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EX-23.1 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - LOOKSMART LTDdex231.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - LOOKSMART LTDdex312.htm
EX-21.1 - LIST OF SUBSIDIARIES - LOOKSMART LTDdex211.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - LOOKSMART LTDdex311.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER - LOOKSMART LTDdex321.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 000-26357

 

 

LOOKSMART, LTD.

(Exact name of Registrant as specified in its charter)

 

Delaware   13-3904355

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

55 Second Street, San Francisco, CA 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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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 x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

Large accelerated filer  ¨   Accelerated filer  ¨
Non-Accelerated filer  ¨ (Do not check if a smaller reporting company)   Smaller Reporting Company  x            

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based upon the closing price of common stock on the last business day of the most recently completed second fiscal quarter, June 30, 2010, was approximately $19,863,976. Shares of voting stock held by each executive officer and director have been excluded from this calculation. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of February 18, 2011, 17,242,091 shares of the registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The information called for by Part III of this Form 10-K is incorporated by reference to the definitive proxy statement for the annual meeting of stockholders of the Company, which will be filed no later than 120 days after December 31, 2010.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page No.  
PART I   
ITEM 1.   

BUSINESS

     2   
ITEM 1A.   

RISK FACTORS

     6   
ITEM 1B.   

UNRESOLVED STAFF COMMENTS

     17   
ITEM 2.   

PROPERTIES

     17   
ITEM 3.   

LEGAL PROCEEDINGS

     18   
ITEM 4.   

(REMOVED AND RESERVED)

     19   
PART II   
ITEM 5.   

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     20   
ITEM 6.   

SELECTED FINANCIAL DATA

     20   
ITEM 7.   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     21   
ITEM 8.   

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     37   
ITEM 9.   

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     66   
ITEM 9A.   

CONTROLS AND PROCEDURES

     66   
ITEM 9B.   

OTHER INFORMATION

     67   
PART III   
ITEM 10.   

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

     67   
ITEM 11.   

EXECUTIVE COMPENSATION

     67   
ITEM 12.   

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

     67   
ITEM 13.   

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

     67   
ITEM 14.   

PRINCIPAL ACCOUNTING FEES AND SERVICES

     67   
PART IV   
ITEM 15.   

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

     67   
   SIGNATURES AND POWER OF ATTORNEY      69   
   EXHIBIT INDEX      70   


Table of Contents

PART I

 

  ·  

This Annual Report on Form 10-K 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 “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 “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections of the 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 preserve our expertise in search advertising network product development,

 

  ·  

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 seasonal fluctuations in internet usage and traditional advertising seasonality are likely to affect our business,

 

  ·  

that we may be unable to maintain or grow sources of revenue,

 

  ·  

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 not be able to recover from the negative revenue impact from the Yahoo!-Bing Search Alliance,

 

  ·  

that we may be unable to maintain profitability,

 

  ·  

that we may be unable to attract and retain key personnel,

 

  ·  

that we may not be able to effectively manage, or to increase, our relationships with international customers,

 

  ·  

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.

 

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ITEM 1.    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. During 2008, we sold the intellectual property rights to the “Wisenut” trademark and related domain names and decided to wind down the Furl operations. The Furl assets were accounted for under the guidance of Accounting Standards Codification (“ASC”) 360-10-40, Impairment or Disposal of Long-Lived Assets (“ASC 360-10-40”) as “assets held for sale” and a full impairment of these assets was recorded at December 31, 2008. In the first quarter of 2009, the Furl assets were sold. The results of operations of consumer product activities, including related gains (losses), have been classified as discontinued operations for all periods presented in the accompanying Consolidated Statements of Operations (see Note 2). At December 31, 2010, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology, and other assets.

Products and Services

LookSmart’s revenue sources are divided into two categories:

 

  1. Advertiser Networks

 

  2. Publisher Solutions

Advertiser Networks

LookSmart develops, markets, and sells premium and performance search advertising products to search advertising customers and related advertising agencies through a variety of pricing models tailored to customer requirements. These search advertising customers reach potential customers with our sponsored search products. Our sponsored search products give search advertising customers complete control of their campaigns with different keyword matching options (Smart, Broad, Negative) and targeting options (Keyword, Category, Geography, Day-parting, or “Run of Network”) to maximize advertiser Return on Investment (“ROI”). Ads are distributed through an extensive network of syndication partners.

 

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LookSmart actively pursues relationships with portals, internet service providers (“ISPs”), media companies, other ad networks, search services and other websites to maintain and increase the distribution of our advertiser’s search advertisements.

These relationships are key drivers of our growth because more distribution typically results in more online search advertising revenues. We derive the majority of our traffic from our pay-per-click (“PPC”) distribution network partners. Each click is verified through our proprietary network traffic monitoring and management process, as well as third-party technologies and tools.

Through a web interface or our proprietary API, LookSmart’s AdCenter allows multiple search advertising customers to upload keywords, manage daily budgets, set rates and view reports—including spend data that is updated hourly. Search advertising customers can also access keyword suggestions, price and traffic estimates, online help and frequently asked questions (“FAQ”). The AdCenter API is also available for search advertising customers and related agencies that use third-party or in-house systems to analyze and manage their search campaigns.

In the fourth quarter of 2010, we began to offer certain search advertising customers the option to purchase advertising on a per view basis, in addition to or in replacement of purchases on a per click basis. We intend to expand our per view offering in 2011 and to develop programs offering purchase on a per action and lead basis.

Publisher Solutions

LookSmart offers a suite of customizable search advertising management tools and solutions that help publishers grow their audience, control advertiser relationships, and enhance and optimize the monetization of their sites. Our Publisher Solutions can be branded and configured according to publishers’ needs. We offer publishers:

 

  ·  

Command and control over revenue diversification and growth via the AdCenter for Publishers, a comprehensive private-labeled Application Service Provider (“ASP”) solution that provides publishers with the ability to own and grow their advertiser relationships, increase their distribution capacity, and diversify their revenue sources.

 

  ·  

A customizable set of services and technology to integrate multiple sources of advertisers, including dominant third-party feeds, within a single auction-based platform for cost-per-click (“CPC”) text-based advertising.

 

  ·  

Access to a “backfill” of advertisers so they can quickly ramp their online operations and not lose time or existing revenue sources while establishing their advertiser relationships. Connecting multiple installations of the AdCenter for Publishers together allows LookSmart to create an open marketplace environment that empowers publishers to share, leverage, and exchange their advertisers for expanded distribution.

Technology

We have developed a proprietary web-based advertising auction platform, the AdCenter, that allows us to create, track, analyze, report and optimize customers’ advertising campaigns. The AdCenter indexes ads, analyzes webpage information to match advertising to relevant content, matches search queries to advertising and utilizes advanced fraud detection techniques in a high-volume ad serving environment. The platform also collects impression and click data for each listing that we manage for our customers and provides us with billing information. In addition, we provide each of our advertising customers with a password-protected online account that enables them to track, analyze and optimize their search marketing campaigns using online reports. The platform also includes an interface for publishers to access ad syndication feed reports and revenue information.

 

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We rely on a combination of patent, trade secret, copyright and trademark laws and contractual provisions to protect our intellectual property and proprietary rights. Our trademarks include LookSmart®. We have an issued patent on our Wisenut search engine technology and have patents pending on various aspects of our ad delivery and search technologies.

Competition

The online search advertising industry is constantly evolving, changes rapidly and is highly competitive. One of the major factors contributing to this competitive environment is that providers of all online advertising formats compete for a share of the advertisers’ limited advertising budgets. The large search engines, such as Yahoo! or Google, often receive the biggest portion of the search marketing budget. With greater capital and technical resources, and greater brand recognition, the larger search engines are often first priority in the mind of the advertiser, agency or buyer.

In 2010, we introduced the LookSmart Quality Manifesto, a commitment to our advertisers, publishers and the entire search marketing community to strive to provide the highest quality search advertising network possible. The introduction of the Quality Manifesto highlights our dedication to finding the best ways to acquire and deliver quality traffic based on values of trust, respect and integrity.

We compete on two main fronts, 1) attracting and growing our base of search advertising customers to purchase our online search advertising products and to incorporate their key words into our search advertising network, and 2) attracting and maintaining distribution network partners to incorporate their search queries into our search advertising network. The basis on which we compete differs among the two fronts. In addition, while internet advertising continues to grow year over year, customers’ online advertising budgets are in competition with advertising in other media such as television, radio and print.

Government Regulations

We are subject to a number of domestic state and federal laws that affect companies conducting business on the Internet. In addition, because of the increasing popularity of the Internet and the growth of online services, laws relating to user privacy, freedom of expression, content, advertising, information security and intellectual property rights are being debated and considered for adoption by many countries throughout the world.

In the U.S., state and federal laws relating to the liability of providers of online services for activities of their consumers, and the liability of providers of online advertisers ads and activities, are currently being tested by a number of claims, which include actions for defamation, libel, invasion of privacy and other data protection claims, tort, unlawful activity, copyright or trademark infringement, or other theories based on the nature and content of the materials searched by consumers, the advertisements shown to consumers or the content generated by consumers. Likewise, other federal laws could have an impact on our business. For example, the Children’s Online Protection Act and the Children’s Online Privacy Protection Act restrict the distribution of materials considered harmful to children and impose additional restrictions on the ability of online services to collect information from minors. In addition, the Protection of Children from Sexual Predators Act of 1998 requires online service providers to report evidence of violations of federal child pornography laws under certain circumstances.

In addition, the application of existing laws regulating or requiring licenses for certain businesses of our search advertising customers, including, for example, distribution of pharmaceuticals, adult content, online gambling, financial services, alcohol or firearms, can be unclear. Application of these laws in an unanticipated manner could expose us to substantial liability and restrict our ability to deliver services to our customers.

Marketing

We use both traditional and non-traditional means and media types to grow our business. In addition to advertising and public relations programs, we seek to retain customers through a mix of informative marketing communications, helpful account tools, continual customer support and an optimal user experience.

 

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We provide relevant content, advertising and technology solutions to advertisers and publishers. Marketing activities are designed to support and grow our business by targeting:

Search Advertising Customers—We deliver online search advertisements to a network of syndicated publishers and search engine partners.

Publishers—We offer a suite of customizable tools and solutions that help publishers grow their audience, search advertiser relationships, and revenue.

Employees

Our future success is substantially dependent on the performance of our senior management and key technical and sales personnel, and our continuing ability to attract and retain highly qualified technical and managerial staff. As of December 31, 2010 we had 52 employees.

On January 7, 2011, our Board of Directors approved a plan of termination that resulted in a reduction of the workforce of approximately 20 full-time positions, or approximately 35%.

See Item 1A. “Risk Factors” for a further discussion on some of the risks we face related to our employees.

Customers

For the year ended December 31, 2010, our overall revenue was concentrated with two customers that are intermediaries, each accounting for more than 10% of net revenue and 25% in aggregate. For the year ended December 31, 2009, our overall revenue was concentrated with one customer, IAC Search and Media (“IAC”).

For the years ended December 31, 2010 and 2009, IAC accounted for 7% of net revenue and 69% of Publisher Solutions revenue, and 16% of net revenue and 81% of Publisher Solutions revenue, respectively. On May 19, 2009, IAC notified us that it did not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement, which provides for certain Publisher Solutions services (the “Agreement”) upon its expiration. The Agreement, as amended, was scheduled to expire by its terms on December 31, 2009 but was extended in one month intervals through October 31, 2010 and expired on that date. In addition, Advertiser Network revenue, totaling $4.9 million, or 10%, for the year ended December 31, 2009, and $1.2 million, or 3%, for the year ended December 31, 2010, was derived from IAC under separate distribution agreements which were terminated in October 2010. We do not expect to generate Publisher Solutions or Advertising Network revenue from IAC in the future.

Product Development and Technical Operations Expense

Product development and technical operations expense includes all costs related to the continued operation, development and enhancement of our core technology product, the AdCenter platform. Our product development and technical operations expense, net of capitalized software development costs, was $9.0 million during the year ended December 31, 2010 and $9.8 million during the year ended December 31, 2009.

Available Information

Our website, www.looksmart.com, provides access, without charge, to our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (“SEC”).

 

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Materials we file with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding our company that we file electronically with the SEC.

ITEM 1A.    RISK FACTORS

You should carefully consider the risks described below before making an investment decision regarding our common stock. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed. In that case, the trading price of our common stock could decline and our investors could lose all or part of their investment. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations.

Risks Related to our Business

Our financial results are highly concentrated in the online search advertising business; if we are unable to grow online search advertising revenues and find alternative sources of revenue, our financial results will suffer

Search advertising accounted for substantially all of our revenues for the years ended December 31, 2009 and 2010. Our success depends upon search advertising customers choosing to use, and distribution network partners choosing to distribute, our search advertising networks products. Search advertising customers and distribution network partners may not adopt our products at projected rates, or changes in market conditions, may adversely affect the use or distribution of search advertisements. Because of our revenue concentration in the online search advertising business, such shortfalls or changes could have a negative impact on our financial results. Also, many of our products are offered to website publishers who use them to display or generate revenue from their online advertisements. Historically, our overall revenue has been concentrated with one customer, IAC Search and Media (“IAC”), accounting for 16% of net revenue and 81% of Publisher Solutions revenue for the year ended December 31, 2009, and 7% of net revenue and 69% of Publisher Solutions revenue for the year ended December 31, 2010. IAC notified us in May 2009 that it did not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement (the “Agreement”), which provides for certain Publisher Solutions services, upon expiration on December 31, 2009, but was extended in one month intervals through October 31, 2010 and expired on that date. In addition, Advertiser Network revenue was derived from IAC under separate distribution agreements, totaling $4.9 million, or 10%, for the year ended December 31, 2009, and $1.2 million, or 3%, for the year ended December 31, 2010, which were terminated in October 2010. We do not expect to generate Publisher Solutions or Advertising Network revenue from IAC in the future. If we are unable to generate significant revenue from our online advertising business, or if market conditions adversely affect the use or distribution of online advertisements generally, or for some of our larger customers specifically, our results of operations, financial condition and/or liquidity will suffer.

Our largest category of customers are intermediaries, the majority of whom purchase clicks to sell into the affiliate networks of large search engine providers; changes in the purchasing patterns of these search engine providers could adversely affect our business and results of operations

We operate in a large online search advertising ecosystem serving ads that target user queries on partner sites. We operate in the middle of this ecosystem, acquiring search queries from a variety of sources and matching them with the keywords of our search advertising customers. Our largest category of customers are intermediaries, the majority of which purchase clicks to sell into the affiliate networks of large search engine providers. If these large search engine providers cease purchasing clicks from these intermediary customers or significantly alter their purchasing methods, the intermediary customers could reduce the amount of clicks they purchase from us, or cease altogether purchasing clicks from us, and that could have a material adverse effect on our business and results of operations.

 

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Our Future Success Depends on Sales to, and the Management of, International Customers

A portion of our revenue is derived from sales to international customers who are headquartered internationally, however our business with them is primarily U.S. based and our transactions are primarily in U.S. dollars.

Managing our growing group of customers outside the U.S. presents various challenges, including, but not limited to:

 

  ·  

economic and political conditions;

 

  ·  

longer payment cycles;

 

  ·  

differences in the enforcement of intellectual property and contract rights in varying jurisdictions;

 

  ·  

our ability to develop relationships with local accounts;

 

  ·  

compliance with U.S. and international laws and regulations;

 

  ·  

fluctuations in foreign currency exchange rates; and

 

  ·  

our ability to secure and retain qualified people for the operation of our business.

To date, foreign exchange exposure from sales has not been material to our operations. Our activities with customers outside the United States may be affected by changes in trade protection laws, policies and measures, and other regulatory requirements affecting trade and investment, including the Foreign Corrupt Practices Act and local laws prohibiting corrupt payments. In addition, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States, which increases the risk of unauthorized use of our technologies. Our business could be materially adversely affected if foreign markets do not continue to develop, if we do not receive additional traffic suitable for our foreign accounts or if regulations governing our international businesses change.

We rely primarily on our distribution network partners to generate quality search queries and display advertisements that generate paid clicks; if we are unable to maintain or expand the scope and quality of this network, our ability to generate revenue may be seriously harmed

The success of our online search advertisement products depends in large part on the size and quality of our distribution network of search queries. We may be unable to maintain or add distribution network partners of satisfactory quality in our distribution network at reasonable revenue-sharing rates, or at all. Our distribution network has been concentrated, with the five largest distribution network partners accounting for approximately 44% and 48% of our Advertiser Networks revenue for the years ended December 31, 2010 and 2009, respectively. If we lose any significant portion of our distribution network, we would need to find alternative sources of quality click traffic to replace the lost paid clicks. In the past, we have lost portions of our distribution network and chose to remove those with poor quality. Although alternate sources of click traffic are currently available in the market, they may not be available at reasonable prices or may be of unacceptable quality. There is significant competition among advertising networks to sign agreements with traffic providers. We may be unable to negotiate and sign agreements with quality traffic providers on favorable terms, if at all. In order to attract higher quality traffic, we may have to pay high traffic acquisition costs which may adversely affect our gross margin and other financial results. If we are unable to attract higher quality traffic, or if we are otherwise unsuccessful in maintaining and expanding our distribution network, then our ability to generate revenue may be seriously harmed.

We generated an operating profit in 2010, but have generated significant losses in the past and may be unable to maintain operating profitability in the future. Failure to maintain operating profitability could result in a decline in our stock price

We had net income of approximately $1.0 million for the year ended December 31, 2010, and a net loss of $6.2 million for the year ended December 31, 2009. As of December 31, 2010, our accumulated deficit was

 

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approximately $234.1 million. We may be unable to maintain profitability in the foreseeable future. Our ability to achieve and maintain profitability will depend on our ability to generate additional revenue and contain our expenses. In order to generate additional revenue, we will need to expand our network of distribution network partners, increase the amount our search advertising customers spend on our advertising network, expand our advertiser base and experience an increase in paid clicks across our network and publisher products. We may be unable to accomplish some or any of these goals because of the risks identified in this report or for unforeseen reasons. Also, we may be unable to contain our costs due to the need to make revenue sharing payments to our distribution network partners, to invest in product development, and market our products. Because of the foregoing factors, and others outlined in this report, we may be unable to maintain profitability in the future, which could result in a decline in our stock price.

If we experience downward pressure on our match rate and/or revenue-per-click, or we are unable to rebuild our match rate, and/or revenue-per-click, our financial results may suffer

We have experienced, and may in the future experience, downward pressure on our average revenue-per-click (“RPC”) and average match rate, which is the rate at which our paid listings are matched against search queries from distribution network partners, due to various market segment, customer, and channel factors. We may experience decreases in RPC or average match rate in the future for many reasons, including a change in customer mix, the erosion of our advertiser base, the reduction in average advertiser spend, the reduction in the number of listings purchased by search advertising customers, the reduction of bids on keywords, changes in the composition of our distribution network or other reasons. If our RPC or average match rate falls for any reason, or if we are unable to grow our RPC and average match rate, then we may be unable to achieve our financial projections and our stock price would likely suffer.

Our growth depends on our ability to retain and grow our search advertising customer base; if our search advertising customer base and average search advertising customer spend falls, our financial results will suffer

Our growth depends on our ability to build a search advertising customer base that corresponds with the characteristics of our distribution network. Our distribution network, which currently consists of a diversified network of distribution sources, may change as new distribution sources are added and old distribution sources are removed. Search advertising customers may view these changes to the distribution network negatively, and existing or potential search advertising customers may elect to purchase fewer or no advertisements for display on our distribution network. If this occurs, it is likely that our average RPC and average match rate may decline and our stock price would likely suffer.

If we do not introduce new and upgraded products and services and successfully adapt to our rapidly changing industry, our financial condition may suffer

The online search advertising industry continues to evolve and we will need to continue developing new and upgraded products and services, and adapt to new business environments and competition in order to maintain and grow revenue and reach our profitability goals. New search advertising technologies could emerge that make our services comparatively less useful or new business methods could emerge that divert web traffic away from our Advertising Network. In addition, competition from other web businesses may prevent us from attracting substantial traffic to our services. Also, we may inaccurately predict the direction of the online search advertising market, which could lead us to make investments in technologies and products that do not generate sufficient returns. We may face platform and resource constraints that prevent us from developing upgraded products and services. We may fail to successfully identify new products or services, or fail to bring new products or services to market in a timely and efficient manner. Rapid industry change makes it difficult for us to accurately anticipate customer needs for our products, particularly over longer periods.

 

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We face intense competitive pressures, which could materially and adversely affect our financial results

We compete in the relatively new and rapidly evolving online search advertising industry, which presents many uncertainties that could require us to further refine our business model. We compete with large companies that provide paid placement products, paid inclusion products, and other forms of search marketing as well as contextually-targeted advertising products and other types of online advertisements. We compete for search advertising customers on the basis of the quality and composition of our network, the price-per-click (“PPC”) charged to search advertising customers, the volume of clicks that we can deliver to search advertising customers, tracking and reporting of campaign results, customer service and other factors. We also compete for distribution network partners and for ad placement on those partners’ sites on the basis of the relevance of our ads and the PPC charged to search advertising customers. We also experience competition in offering our publisher products to website publishers. Some of our competitors have larger distribution networks and proprietary traffic bases, longer operating histories, greater brand recognition, higher RPC, better relevance and conversion rates, or better products and services than we have.

The Yahoo!-Bing Search Alliance integration that was implemented the fourth quarter of 2010 had a negative impact on our Advertiser Networks revenue. Yahoo! partners are our largest customer group, and all partners were affected by significantly lower RPC following the integration that led to reduced payments and consequently lower revenues.

Our acquisition of businesses and technologies may be costly and time-consuming; acquisitions may also dilute our existing stockholders

From time to time we evaluate corporate development opportunities and when appropriate, may make acquisitions of or significant investments in, complementary companies or technologies to increase our technological capabilities expand our service offerings, or extend the operating scale of our network businesses. The pursuit of acquisitions, whether or not completed, as well as the completion of any acquisitions and their integration may be expensive and may divert the attention of management from the day-to-day operations of the company. It may be difficult to retain key management and technical personnel of the acquired company during the transition period following an acquisition. Acquisitions or other strategic transactions may also result in dilution to our existing stockholders if we issue additional equity securities or increase our debt. We may also be required to amortize significant amounts of intangible assets, record impairment of goodwill in connection with future acquisitions, or divest non-performing assets at below-market prices, which would adversely affect our operating results. Integration of acquired companies and technologies into the company is likely to be expensive, time-consuming and strain our managerial resources. We may not be successful in integrating any acquired businesses or technologies and these transactions may not achieve anticipated business benefits.

Our success depends on our ability to attract and retain key personnel; if we were unable to attract and retain key personnel in the future, our business could be materially and adversely impacted

Our success depends on our ability to identify, attract, retain and motivate highly skilled development, technical, sales, and management personnel. We have a limited number of key development, technical, sales and management personnel performing critical company functions, and the loss of the services of any of our key employees, particularly any of our executive team members or key technical personnel, could adversely affect our business. The combination of depressed capital markets, stock volatility and small market capitalization may not allow us to offer competitive equity based compensation to attract and retain key personnel. We have experienced significant restructurings and turnover which has placed additional burdens on our remaining personnel. Over the past fifteen months, our General Counsel, Chief Executive Officer, Vice President and General Manager, Advertising Platforms, Chief Financial Officer and Vice President, Advertiser Networks have all left the Company. We cannot ensure that we will be able to retain our key employees or that we can identify, attract and retain highly skilled personnel in the future.

We face capacity constraints on our software and infrastructure systems that may be costly and time-consuming to resolve

We use proprietary and licensed software and databases to receive and analyze advertisements, campaigns and budgets, match search queries to advertising, analyze webpage information to match advertising to relevant

 

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content, integrate third-party ads, detect invalid clicks, serve ads in high volume, and track, analyze and report on advertising responses and campaigns. Any of these software systems may contain undetected errors, defects or bugs or may fail to operate with other software applications. The following developments may strain our capacity and result in technical difficulties with our service or the websites of our distribution network partners:

 

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customization of our matching algorithms and ad serving technologies,

 

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substantial increases in the number of queries to our database,

 

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substantial increases in the number of searches in our advertising databases, or

 

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the addition of new products or new features or changes to our products.

If we experience difficulties with our software and infrastructure systems or if we fail to address these difficulties in a timely manner, we may lose the confidence of search advertisers and distribution network partners, our revenue may decline and our business could suffer. In addition, as we expand our service offerings and enter into new business areas, we may be required to significantly modify and expand our software and infrastructure systems. If we fail to accomplish these tasks in a timely manner, our business will likely suffer.

Our ability to obtain new credit facilities may adversely affect the way we conduct our business

On April 30, 2010, our bank lease line expired. We may need to enter into additional credit facilities in the future to operate the business. Our history of operating losses may make it more difficult for us to obtain additional financing for our operations, investing activities, or financing activities. This difficulty or inability could materially limit our business operations and adversely affect our business performance.

If we do not comply with the financial covenants in our credit agreements, our financial condition could be adversely affected.

Our credit facilities contain provisions that could limit our ability to, among other things, incur, create or assume additional debt, sell or otherwise dispose of our or any of our subsidiary’s assets, or consolidate or merge with or into, or acquire the obligations or stock of, or any other interest in, another person. In addition, our credit facilities contain financial covenants that require us to maintain specified levels of tangible net worth and liquid assets. Our ability to meet those financial covenants can be affected by events beyond our control, and we may be unable to satisfy these covenants. If we fail to comply with these covenants, we may be required to identify restricted cash equal to our outstanding capital lease balance plus our outstanding standby letter of credit (“SBLC”) or, in the event of default, we may be required to pay the lenders cash in an amount equal to the capital lease balance. Paying such cash balances could have a material adverse effect on the Company’s financial condition.

Risks Related to Operating in our Industry

Economic conditions, political events, and other circumstances could materially adversely affect the Company

The Company’s operations and performance depend significantly on worldwide economic conditions and their impact on levels of consumer spending in many countries and regions, including without limitation the United States, and may remain depressed for some time. Some of the factors that could influence the levels of consumer spending and, in turn, online advertising, include continuing volatility in fuel and other energy costs, conditions in the residential real estate and mortgage markets, labor and healthcare costs, access to credit, consumer confidence and other macroeconomic factors affecting consumer spending behavior and, in turn, online advertising. These and other economic factors could have a material adverse effect on demand for the Company’s products and services and on the Company’s financial condition and operating results.

 

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Cyclical and seasonal fluctuations in the economy, in internet usage and in traditional retail shopping may have an effect on our business

Both cyclical and seasonal fluctuations in internet usage and traditional retail seasonality may affect our business. Internet usage generally slows during the summer months, and queries typically increase significantly in the fourth quarter of each year. These seasonal trends may cause fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates.

If we fail to prevent, detect and remove invalid search queries and clicks, we could lose the confidence of our search advertisers, thereby causing our business to suffer

Invalid clicks are an ongoing problem for the Internet search advertising industry, and we are exposed to the risk of invalid clicks on our search advertising customers’ text advertisements coming from within our distribution network. Invalid clicks occur when a person or robotic software causes a click on a paid listing to occur for some reason other than to view the underlying content. Invalid clicks are commonly referred to as “click fraud.” We continue to invest significant time and resources in preventing, detecting and eliminating invalid traffic from our distribution network. However, the perpetrators of click fraud have developed sophisticated methods to evade detection, and we are unlikely to be able to completely detect and remove all invalid traffic from our search network.

We are subject to advertiser complaints and litigation regarding invalid clicks, and we may be subject to search advertising customer complaints, claims, litigation or inquiries in the future. For example, in March 2005, the Company was served with the second amended complaint in a class action lawsuit (Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc.) alleging that the Company engaged in click fraud and seeking damages as a result. We have from time to time credited invoices or refunded revenue to our customers due to invalid traffic, and we expect to continue to do so in the future. If our systems to detect invalid traffic are insufficient, or if we find new evidence of past invalid clicks, we may have to issue credits or refunds retroactively to our search advertisers, and we may still have to pay revenue share to our distribution network partners. This could negatively affect our profitability and hurt our brand. If traffic consisting of invalid clicks is not detected and removed from our advertising network, the affected search advertising customers may experience a reduced return on their investment in our online advertising because the invalid clicks will not lead to conversions for the search advertising customers. This could lead the search advertisers to become dissatisfied with our products, which could lead to loss of search advertising customers and revenue and could materially and adversely affect our financial results.

Any failure in the performance of our key production systems could materially and adversely affect our revenues

Any system failure that interrupts our hosted products or services, whether caused by computer viruses, software failure, power interruptions, intruders and hackers, or other causes, could harm our financial results. For example, our system for tracking and invoicing clicks is dependent upon a proprietary software platform. If we lose key personnel or experience a failure of software, this system may fail. In such event, we may be unable to track paid clicks and invoice our customers, which would materially and adversely affect our financial results and business reputation. Moreover, our services are governed by Service Level Agreements that, if not met, require the payment of credits to our customers depending upon the level of service interruption.

The occurrence of a natural disaster or unanticipated problems at our principal headquarters or at a third-party data center could cause interruptions or delays in our business. A loss of data could render us unable to provide some services. Our California facilities exist on or near known earthquake fault zones and a significant earthquake could cause an interruption in our services. We do not have back-up facilities for our San Francisco, California headquarters, where the majority of our employees reside. We completed the transition of our data center to a new location in Sacramento, California in May 2010. An interruption in our ability to serve advertisements, track paid clicks, bill and collect invoices, and provide customer support would materially and adversely affect our financial results.

 

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Our business and operations depend on Internet service providers and third party technology providers, and any failure or system downtime experienced by these companies could materially and adversely affect our revenues

Our distribution network partners and search advertising customers depend on Internet service providers, online service providers and other third parties for access to our services. These service providers have experienced significant outages in the past and could experience outages, delays and other operating difficulties in the future. The occurrence of any or all of these events could adversely affect our reputation, brand and business, which could have a material adverse effect on our financial results.

We currently have an agreement with Raging Wire Enterprise Solutions, Inc. (“Raging Wire”) to house equipment for web serving and networking and to provide network connectivity services. We terminated our relationship with Savvis and completed our relocation of equipment in May 2010. We also have agreements with third-party click tracking and ad-serving technology providers. We do not presently maintain fully redundant click tracking, customer account and web serving systems at separate locations. Accordingly, our operations depend on Raging Wire to protect the systems in their data centers from system failures, earthquake, fire, power loss, water damage, telecommunications failure, hackers, vandalism and similar events. Raging Wire does not guarantee that our Internet access will be uninterrupted, error-free or secure. Although we maintain property insurance and business interruption insurance, such insurance may not protect against some risks and we cannot guarantee that our insurance will be adequate to compensate us for all losses that may occur as a result of a catastrophic system failure. Also, if our third-party click tracking or ad-serving technology providers experience service interruptions, errors or security breaches, our ability to track, realize and record revenue would suffer.

We may face liability for claims related to our products and services, and these claims may be costly to resolve

Internet users, search advertisers, other customers, and companies in the Internet, technology and media industries frequently enter into litigation based on allegations related to defamation, negligence, personal injury, breach of contract, unfair advertising, unfair competition, invasion of privacy or other claims. Lawsuits are filed against us from time to time. As we enter foreign markets, our potential liability could increase. In addition, we are obligated in some cases to indemnify our customers or distribution network partners in the event that they are subject to claims that our services infringe on the rights of others.

Litigating these claims could consume significant amounts of time and money, divert management’s attention and resources, cause delays in integrating acquired technology or releasing new products, or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on acceptable terms, if at all. Our insurance may not adequately cover claims of this type, if at all. If a court were to determine that some aspect of our services infringed upon or violated the rights of others, we could be prevented from offering some or all of our services, which would negatively impact our revenue and business. For any of the foregoing reasons, litigation involving our listings business and technology could have a material adverse effect on our business, operating results and financial condition.

We could be subject to infringement claims that may be costly to defend, result in the payment of settlements or damages or cause us to change the way we conduct our business

Internet, technology and media companies, as well as patent holding companies often possess a significant number of patents. Further, many of these companies and other parties are actively developing online advertising, search, indexing, electronic commerce and other Web-related technologies, as well as a variety of online business models and methods. We believe that these parties will continue to take steps to protect these technologies, including, but not limited to, seeking patent protection. As a result, we may face claims of infringement of patents and other intellectual property rights held by others. Also, as we expand our business, acquire and maintain our customer base, and develop new technologies, products and services, we may become increasingly

 

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subject to intellectual property infringement claims. In the event that there is a claim or determination that we infringe third-party proprietary rights such as patents, copyrights, trademark rights, trade secret rights or other third party rights such as publicity and privacy rights, we could incur substantial monetary liability, be required to enter into costly royalty or licensing agreements or be prevented from using the rights, which could require us to change our business practices in the future and limit our ability to compete effectively. We may also incur substantial expenses in defending against third-party infringement claims regardless of the merit of such claims. The occurrence of any of these results could harm our brand and negatively impact our operating results. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain third-party intellectual property infringement claims or determinations, which could increase our costs in defending such claims and our damages. For example, in October 2008, we agreed to indemnify one of our Publisher Solutions customers relating to a patent infringement suit filed against it pursuant to an AdCenter for Publishers’ agreement between it and the Company. The resulting settlement agreement between the Company and the plaintiffs required us to pay the plaintiffs $0.6 million and the Publisher Solutions customer’s defense costs of $0.4 million.

Litigation, regulation, legislation or enforcement actions directed at or materially affecting us may adversely affect the commercial use of our products and services and our financial results

New lawsuits, laws, regulations and enforcement actions applicable to the online industry may limit the delivery, appearance and content of our advertising or our publisher customers’ advertisers or otherwise adversely affect our business. If such laws are enacted, or if existing laws are interpreted to restrict the types and placements of advertisements we or our publishers’ customers can carry, it could have a material and adverse effect on our financial results. For example, in 2002, the Federal Trade Commission, in response to a petition from a private organization, reviewed the way in which search engines disclose paid placement or paid inclusion practices to Internet consumers and issued guidance on what disclosures are necessary to avoid misleading consumers about the possible effects of paid placement or paid inclusion listings on the search results. In 2003, the United States Department of Justice issued statements indicating its belief that displaying advertisements for online gambling might be construed as aiding and abetting an illegal activity under federal law. In 2004, the United States Congress considered new laws regarding the sale of pharmaceutical products over the Internet and the use of adware to distribute advertisements on the Internet. In 2007, the Federal Trade Commission proposed new regulations relating to online behavioral targeting. Moreover, as we enter into foreign markets, we may become subject to additional regulation and legislation. If any new law or government agency were to require changes in the labeling, delivery or content of our advertisements, or if we are subject to legal proceedings regarding these issues, it may reduce the desirability of our services or the types of advertisements that we can run, and our business could be materially and adversely harmed. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain claims related to online advertising laws, regulations and enforcement actions, which could increase our costs in defending such claims and our damages.

In addition, legislation or regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), present ongoing compliance risks, and a failure to comply with these new laws and regulations could materially harm our business. As we continue our Section 404 compliance efforts we may identify significant deficiencies, or material weaknesses, in the design and operation of our internal control over financial reporting. We may be unable to remediate any of these matters in a timely fashion, and/or our independent registered public accounting firm may not agree with our remediation efforts. Such failures could impact our ability to record, process, summarize and report financial information, and could impact market perception of the quality of our financial reporting, which could adversely affect our business and our stock price.

Privacy-related regulation of the Internet could limit the ways we currently collect and use personal information, which could decrease our advertising revenues or increase our costs

Internet user privacy has become an issue both in the United States and abroad. The United States Congress and Federal Trade Commission are considering new legislation and regulations to regulate Internet privacy. The

 

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Federal Trade Commission and government agencies in some states and countries have investigated some Internet companies, and lawsuits have been filed against some Internet companies, regarding their handling or use of personal information. Any laws imposed to protect the privacy of Internet consumers may affect the way in which we collect and use personal information. We could incur additional expenses if new laws or court judgments, in the United States or abroad, regarding the use of personal information are introduced or if any agency chooses to investigate our privacy practices.

In addition, our search advertisers and partners may place information, known as cookies, on a user’s hard drive, generally without the user’s knowledge or consent. This technology enables web site operators to target specific consumers with a particular advertisement, to limit the number of times a user is shown a particular advertisement, and to track certain behavioral data. Although some Internet browsers allow consumers to modify their browser settings to remove cookies at any time or to prevent cookies from being stored on their hard drives, many consumers are not aware of this option or are not knowledgeable enough to use this option. Some privacy advocates and governmental bodies have suggested limiting or eliminating the use of cookies. If this technology is reduced or limited, the Internet may become less attractive to search advertisers and sponsors, which could result in a decline in our revenue.

We, along with some of our distribution network partners or search advertising customers retain information about our consumers. If others were able to penetrate the network security of these user databases and access or misappropriate this information, we and our distribution network partners or search advertising customers could be subject to liability. These claims may result in litigation, our involvement in which, regardless of the outcome, could require us to expend significant time and financial resources. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain claims related to privacy laws, regulations and enforcement actions which could increase our costs in defending such claims and damages.

Online commerce security risks, including security breaches, identity theft, service disrupting attacks and viruses, could harm our reputation and the conduct of our business, which could have a material adverse effect on our financial results

A fundamental requirement for online commerce and communications is the secure storage and transmission of confidential information over public networks. Although we have developed and use systems and processes that are designed to protect customer information and prevent fraudulent credit card transactions and other security breaches, our security measures may not prevent security breaches or identity theft that could harm our reputation and business. Currently, a significant number of our customers provide credit card and other financial information and authorize us to bill their credit card accounts directly for all transaction fees charged by us. We rely on encryption and authentication technology to provide the security and authentication to effect secure transmission of confidential information, including customer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology used by us to protect transaction data. In addition, any party who is able to illicitly obtain a user’s password could access the user’s transaction data. An increasing number of websites have reported breaches of their security. Any compromise of our security could damage our reputation and expose us to a risk of litigation and possible liability. The coverage limits of our insurance policies may not be adequate to reimburse us for losses caused by security breaches.

Additionally, our servers are vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions, and we have experienced “denial-of-service” type attacks on our system that have made all or portions of our websites unavailable for periods of time. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches. Disruptions in our services and damage caused by viruses and other attacks could cause a loss of user confidence in our systems and services, which could lead to reduced usage of our products and services and materially adversely affect our business and financial results.

 

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New tax treatment of companies engaged in Internet commerce may adversely affect the commercial use of our search service and our financial results

Tax authorities at the international, federal, state and local levels are currently reviewing the appropriate tax treatment of companies engaged in Internet commerce. New or revised state tax regulations may subject us or our search advertising customers to additional state sales, income and other taxes. We cannot predict the effect of current attempts to impose sales, income or other taxes on commerce over the Internet. New or revised taxes and, in particular, sales taxes, would likely increase the cost of doing business online and decrease the attractiveness of advertising and selling goods and services over the Internet. Any of these events could have an adverse effect on our business and results of operations.

Risks Related to the Capital Market

Our securities may be delisted

The NASDAQ Stock Market requires us to satisfy certain continued listing requirements, including maintaining a minimum closing bid price for our common stock of at least $1.00 per share. On March 9, 2010, NASDAQ sent us a letter stating that we were out of compliance with that requirement and that we had until September 7, 2010, to regain compliance by having our common stock close at or above the $1.00 per share minimum closing bid price for 10 consecutive trading days. On April 26, 2010, we received a letter from NASDAQ stating that we had regained compliance with the minimum closing bid price requirement and that the matter was closed. However, should our stock price again close under the $1.00 per share minimum closing bid price for 30 consecutive days, we could again be deemed out of compliance with the minimum closing bid price requirement and be forced to consider various actions to regain compliance, including a reverse stock split of our common stock. No assurance can be given that we will remain in compliance with all of the NASDAQ Stock Market’s continued listing requirements. If delisting were to occur, our securities will not enjoy the same liquidity as shares that are traded on the NASDAQ Stock Market or a national U.S. securities exchange and investors may find that it is more difficult to obtain accurate and timely quotations. As a result, the price of our securities would likely decline.

Our quarterly revenues and operating results may fluctuate for many reasons, each of which may negatively affect our stock price

Our revenues and operating results will likely fluctuate significantly from quarter to quarter as a result of a variety of factors, including without limitation:

 

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change in the composition of our Advertiser Network customer base,

 

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change in composition of our AdCenter customer base,

 

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changes in our distribution network, particularly the gain or loss of key distribution network partners, or changes in the implementation of search results on partner websites,

 

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changes in the number of search advertising customers who do business with us, or the amount of spending per customer,

 

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the revenue-per-click we receive from search advertising customers, or other factors that affect the demand for, and prevailing prices of, Internet advertising and marketing services,

 

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change in our traffic acquisition costs (TAC) related to our Advertiser Network, or

 

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systems downtime on our Advertiser Network, our website or the websites of our distribution network partners.

Due to the above factors, we believe that period-to-period comparisons of our financial results are not necessarily meaningful, and you should not rely on past financial results as an indicator of our future performance. If our financial results in any future period fall below the expectations of securities analysts and investors, the market price of our securities would likely decline.

 

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Our long-lived assets may be subject to greater risk of impairment if we undergo a change of control limiting the use of our net operating losses

As of December 31, 2010, we had net operating losses (NOLs) amounting to approximately $178.9 million for federal income tax purposes. We can utilize these NOLs in certain circumstances to offset future U.S. taxable income and reduce our U.S. federal income tax liability, which may arise even in periods when we incur an accounting loss for reporting purposes. We also include these NOL benefits in the calculation associated with testing for impairment of our long-lived assets. However, our ability to utilize our NOLs for these purposes would be substantially limited if there were an “ownership change” as defined under Section 382 of the Internal Revenue Code. In general, an ownership change would occur if certain ownership changes related to our stock held by 5% or greater shareholders exceeded 50%, measured over a rolling three year period beginning with the last ownership change. These provisions can be triggered not only by merger and acquisition activity, but also by stock repurchases and normal market trading of our common stock. While we have not undergone a change of control under Section 382 since 2003, we were close to the threshold in 2008 and 2009, and no assurance can be given that such a change of control will not occur in the future. Should we undergo such a change of control, our ability to utilize our NOLs to offset future U.S. taxable income and reduce our U.S. federal income tax liability may be limited in certain circumstances. This, in turn, would affect our ability to utilize the NOLs in the calculations associated with testing for impairment of our long-lived assets used in operations, which could result in an increased likelihood of such impairment.

Our stock price is extremely volatile, and such volatility may hinder investors’ ability to resell their shares for a profit or avoid a loss

The stock market has experienced significant price and volume fluctuations in recent years, and the stock prices of Internet companies have been extremely volatile. The low trading volume of our common stock may adversely affect its liquidity and reduce the number of market makers and/or large investors willing to trade in our common stock, making wider fluctuations in the quoted price of our common stock more likely to occur. You should evaluate our business in light of the risks, uncertainties, expenses, delays and difficulties associated with managing and growing a business in a relatively new industry, many of which are beyond our control.

Our stock price may fluctuate, and you may not be able to sell your shares for a profit, as a result of a number of factors including without limitation:

 

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changes in the market valuations of Internet companies in general and comparable companies in particular,

 

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quarterly fluctuations in our operating results,

 

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the termination or expiration of our distribution agreements,

 

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our potential failure to meet our forecasts or analyst expectations on a quarterly basis,

 

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the relatively thinly traded volume of our publicly traded shares, which means that small changes in the volume of trades may have a disproportionate impact on our stock price,

 

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the loss of key personnel, or our inability to recruit experienced personnel to fill key positions,

 

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changes in ratings or financial estimates by analysts or the inclusion/removal of our stock from certain stock market indices used to drive investment choices,

 

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announcements of new distribution network partnerships, technological innovations, acquisitions or products or services by us or our competitors,

 

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the sales of substantial amounts of our common stock in the public market by our stockholders, or the perception that such sales could occur, or

 

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conditions or trends in the Internet that suggest a decline in rates of growth of advertising-based Internet companies.

 

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In the past, securities class action litigation has often been instituted after periods of volatility in the market price of a Company’s securities. A securities class action suit against us could result in substantial costs and the diversion of management’s attention and resources, regardless of the merits or outcome of the case.

We may need additional capital in the future to support our operations and, if such additional financing is not available to us, on reasonable terms or at all, our liquidity and results of operations will be materially and adversely impacted

Although we believe that our working capital will provide adequate liquidity to fund our operations and meet our other cash requirements for the foreseeable future, unanticipated developments in the short term, such as the entry into agreements which require large cash payments or the acquisition of businesses with negative cash flows, may necessitate additional financing. We may seek to raise additional capital through public or private debt or equity financings in order to:

 

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fund the additional operations and capital expenditures,

 

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take advantage of favorable business opportunities, including geographic expansion or acquisitions of complementary businesses or technologies,

 

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develop and upgrade our technology infrastructure beyond current plans,

 

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develop new product and service offerings,

 

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take advantage of favorable conditions in capital markets, or

 

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respond to competitive pressures.

The capital markets, and in particular the public equity market for Internet companies, have historically been volatile. It is difficult to predict when, if at all, it will be possible for Internet companies to raise capital through these markets. We cannot assure you that the additional financing will be available on terms favorable to us, or at all. If we issue additional equity or convertible debt securities, our existing stockholders may experience substantial dilution.

Provisions of Delaware corporate law and provisions of our charter and bylaws may discourage a takeover attempt

Our charter and bylaws and provisions of Delaware law may deter or prevent a takeover attempt, including an attempt that might result in a premium over the market price for our common stock. Our board of directors has the authority to issue shares of preferred stock and to determine the price, rights, preferences and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. In addition, our charter and bylaws provide for a classified board of directors. These provisions, along with Section 203 of the Delaware General Corporation Law, prohibiting certain business combinations with an interested stockholder, could discourage potential acquisition proposals and could delay or prevent a change of control.

ITEM 1B.    UNRESOLVED STAFF COMMENTS

None.

ITEM 2.    PROPERTIES

The Company subleases 19,997 square feet of office space for our headquarters in San Francisco, California, under an operating lease expiring on December 30, 2014. In addition to scheduled base rent payments, the Company will also be responsible for varying amounts of operating and property tax expenses.

 

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The Company leases a sales office in New York, New York, under an operating lease that expires in December 2011.

The Company maintains a data center in Sacramento, California, under a Master Service Agreement and related Service Level Agreement that expires in January 2012.

We believe our existing facilities are suitable for company operations.

ITEM 3.    LEGAL PROCEEDINGS

Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc.

On March 14, 2005, the Company was served with the second amended complaint in a class action lawsuit in the Circuit Court of Miller County, Arkansas. The complaint names eleven search engines and web publishers as defendants, including the Company, and alleges breach of contract, restitution/unjust enrichment/money had and received, and civil conspiracy claims in connection with contracts allegedly entered into with plaintiffs for Internet pay-per-click advertising. The named plaintiffs on the second amended complaint are Lane’s Gifts and Collectibles, L.L.C., U.S. Citizens for Fair Credit Card Terms, Inc., Savings 4 Merchants, Inc., and Max Caulfield d/b/a Caulfield Investigations.

On March 30, 2005, the case was removed to United States District Court for the Western District of Arkansas. On April 4, 2005, plaintiffs U.S. Citizens for Fair Credit Card Terms, Inc. and Savings 4 Merchants, Inc. filed a motion of voluntary dismissal without prejudice. The motion was granted on April 7, 2005. Plaintiffs Lane’s Gifts and Collectibles, L.L.C. and Max Caulfield d/b/a Caulfield Investigations filed a motion to remand the case to state court on April 13, 2005, which was granted in September 2005. In July 2005, defendants, including the Company, petitioned the Eighth Circuit Court of Appeals for an appeal of the remand order, and moved to stay the proceedings while the appeal was pending. The petition was denied on September 8, 2005 and the case was remanded to the Circuit Court of Miller County, Arkansas. The Company was served with discovery requests on October 7, 2005. The Company has filed and/or joined motions to dismiss on the basis of failure to state a claim upon which relief can be granted, lack of personal jurisdiction, and improper venue. Pursuant to the court’s initial scheduling order, plaintiffs had until January 27, 2006 to respond to the motions to dismiss for lack of personal jurisdiction and improper venue; and until September 9, 2006 to respond to the motion to dismiss on the basis of failure to state a claim upon which relief can be granted. However the court entered an order staying all proceedings for a period of 60 days on January 9, 2006. On April 20, 2006, the Court preliminarily approved a class settlement among plaintiffs, defendant Google, Inc., and certain defendants who display Google advertisements on their networks (the “Google Settlement”). The Google Settlement purports to release Google of all claims and also purports to release certain defendants, including the Company, for any claims associated with the display of Google advertisements on their networks. On July 24 and 25, 2006, the Court had a final settlement hearing on the Google Settlement, and on July 26, 2006, the Court approved the settlement. On April 21, 2006, the Court ordered the remaining defendants, including the Company, to mediation and further stayed the proceedings to September 21, 2006. The Court further extended the stay as to LookSmart until August 16, 2006. The parties thereafter stipulated that the stay would remain in effect while the parties continue to comply with the Court’s order regarding mediation. On January 10, 2007, the Court further extended the stay until May 1, 2007. On or about November 20, 2007, the Plaintiffs and the Company entered into a Stipulation and Settlement Agreement (the “Settlement Agreement”) to settle the matter in its entirety. On or about November 29, 2007, the Court preliminarily approved the Settlement Agreement and on February 29, 2008, the court entered an order to approve as final the Settlement Agreement. Pursuant to the Settlement Agreement, the Company has agreed to establish a Settlement Fund in the amount of up to approximately $2.5 million to be allocated as follows: (a) the Class Member Fund which should not exceed approximately $2.0 million in advertising credits, (b) the Fees Award to Class Counsel, which shall not exceed the amount of approximately $0.6 million; and (c) the Incentive Award (as hereinafter defined) to the three Class Representatives, which shall not exceed a collective immaterial amount. In the event that the total of the credit claims paid is less than

 

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approximately $0.8 million, the difference between the total amount of the credit claims paid and approximately $0.8 million will be paid to charities in the form of advertising credits. Should the total of the credit claims paid to the Settlement Class Members as a group plus any amounts allocated to charities be more than approximately $0.8 million but less than approximately $2.5 million, then the amount if any shall be retained by the Company. Settlement payments from the Class Member Fund will be paid out in advertising credits to members of the Class who file timely claims to participate in the settlement. On December 28, 2007, the Company provided the notices to class members required by the Settlement Agreement who had until February 11, 2008 to file claims. On April 8, 2008, the Company made the Fee Award to Counsel and the Incentive Award payments to plaintiffs’ counsel. On April 29, 2008, the Company began to issue advertising credits to the Class Members who filed timely claims. The Company recorded an estimate in accrued liabilities of the amount of the loss on settlement which management determined was probable and estimable during the year ended December 31, 2007. This estimate may change as a result of the cost of the final settlement arrangement. In addition, during 2007, the Company recovered settlement proceeds from the insurance carrier, which exceeded the recorded estimate of the amount of loss on settlement. Due to the uncertainty relating to the ultimate settlement amount, the excess settlement proceeds have been recorded as an accrued liability at December 31, 2009 and 2010.

Upon the completion of the thirty day appeals period, which ended on March 30, 2008, the Company on April 7, 2008 paid approximately $0.6 million of legal fees to the plaintiff’s counsel representing the Fees Award to Class Counsel and the Incentive Award as is stipulated in the Settlement Agreement. As of December 31, 2010, the Company has provided approximately $0.1 million of advertising credits to Class Member and $0.3 million remains recorded as an accrued liability.

Additionally, we are involved, from time to time, in various legal proceedings arising from the normal course of business activities. Although the results of litigation and claims cannot be predicted with certainty, we do not expect resolution of these matters to have a material adverse impact on our consolidated results of operations, cash flows or financial position. However, an unfavorable resolution of a matter could, depending on its amount and timing, materially affect our future results of operations, cash flows or financial position in a future period. Regardless of the outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors.

Additionally, pursuant to Section 17.06A(e) of the Internal Revenue Code, we have not been required to pay a penalty to the Internal Revenue Service for failing to make disclosures required with respect to certain transactions that have been identified by the IRS as abusive or that have a significant tax avoidance purpose.

ITEM 4.    (Removed and Reserved)

 

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PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

LookSmart, Ltd. common stock is quoted on the Nasdaq Global Market under the symbol “LOOK”. The following table sets forth the range of high and low sales prices of the common stock on the Nasdaq Global Market for each period indicated:

 

     HIGH      LOW  

2009

     

First quarter

   $ 1.78       $ 0.82   

Second quarter

   $ 1.56       $ 1.00   

Third quarter

   $ 1.40       $ 1.01   

Fourth quarter

   $ 1.40       $ 0.95   

2010

     

First quarter

   $ 1.16       $ 0.88   

Second quarter

   $ 1.95       $ 0.96   

Third quarter

   $ 2.35       $ 1.15   

Fourth quarter

   $ 2.48       $ 1.86   

2011

     

First quarter (through February 18, 2011)

   $ 2.26       $ 1.47   

LookSmart had approximately 4,830 holders of record of common stock as of February 18, 2011. We have not declared or paid any cash dividends on the common stock and presently intend to retain our future earnings, if any, to fund the development and growth of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future.

Information about our outstanding stock options, weighted average exercise prices, and number of stock options available for future grant, under both stockholder-approved stock plans and non-stockholder-approved stock plans will be included in our proxy statement for the 2011 annual meeting of stockholders, and is hereby incorporated by reference into this Annual Report.

Recent Sales of Unregistered Securities; Uses of Proceeds from Registered Securities

We had no sales of unregistered securities in 2010 and 2009.

ITEM 6.    SELECTED FINANCIAL DATA

As a smaller reporting company, as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we are not required to provide the information required by this item.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

  ·  

The following discussion should be read in conjunction with the Consolidated Financial Statements and the Notes to those statements that appear elsewhere in this Annual Report on Form 10-K.

 

  ·  

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 “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 “Business,” “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 preserve our expertise in online advertising,

 

  ·  

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 maintain or grow sources of revenue,

 

  ·  

that seasonal fluctuations in internet usage and traditional advertising seasonality are likely to affect our business,

 

  ·  

that changes in the distribution network composition may lead to decreases in traffic 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 not be able to recover from the negative revenue impact from the Yahoo!-Bing Search Alliance,

 

  ·  

that we may be unable to maintain profitability,

 

  ·  

that we may be unable to attract and retain key personnel,

 

  ·  

that we may not be able to effectively manage, or to increase, our relationships with international customers,

 

  ·  

that we may have unexpected increases in costs and expenses, or

 

  ·  

that one or more of the other risks described above in the section entitled “Risk Factors” (Item 1A of this Annual Report on Form 10-K) 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.

 

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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 (losses), have been classified as discontinued operations for all periods presented in the accompanying Consolidated Statements of Operations (see Note 2). At December 31, 2010, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology, and other assets.

Critical Accounting Policies and Estimates

Our financial condition and results of operations are based upon certain critical accounting policies, which include estimates, assumptions, and judgments on the part of management. We base our estimates on various factors and information which may include, but are not limited to, history and prior experience, experience of other enterprises in the same industry, new related events, current economic conditions and information from third party professionals that is believed to be reasonable under the circumstance, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. Actual results may differ from those estimates.

The following discussion highlights those policies and the underlying estimates and assumptions, which we consider critical to an understanding of the financial information in this report.

Use of Estimates and Assumptions

The 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

 

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that affect the reported amounts of assets and liabilities, revenue, expenses, and contingent assets and liabilities during the reporting period. We base our estimates on various factors and information which may include, but are not limited to, history and prior experience, experience of other enterprises in the same industry, new related events, and current economic conditions and information from third party professionals that is believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

Investments

We invest our excess cash primarily in debt instruments of high-quality corporate and government issuers. All highly liquid instruments with maturities at the date of purchase greater than ninety days are considered investments. All instruments with maturities greater than one year from the balance sheet date are considered long-term investments unless management intends to liquidate such securities in the current operating cycle. Such securities are classified as short-term investments. These securities are classified as available-for-sale and carried at fair value.

Changes in value of these investments are primarily related to changes in interest rates and are considered to be temporary in nature. Except for declines in fair value that are not considered temporary, net unrealized gains or losses on these investments are reported as a component of accumulated other comprehensive income (loss) in stockholders’ equity. We recognize realized gains and losses upon sale of investments using the specific identification method.

Fair Value of Financial Instruments

Our estimates of fair value for assets and liabilities is based on a framework that establishes a hierarchy of the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions. The three levels of the hierarchy are as follows:

 

  Level 1: Unadjusted quoted market prices for identical assets or liabilities in active markets that we have the ability to access.

 

  Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, default rates, etc.) or can be corroborated by observable market data.

 

  Level 3: Valuations based on models where significant inputs are not observable. The unobservable inputs reflect our assumptions about the assumptions that market participants would use.

Revenue Recognition

Our online search advertising revenue is primarily composed of per-click fees that we charge customers. The per-click fee charged for keyword-targeted listings is calculated based on the results of online bidding for keywords or page content, up to a maximum cost per keyword or page content set by the customer. Revenue also includes revenue share from licensing of private-labeled versions of our 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

 

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been satisfied, and no refund obligations exist. We pay distribution network partners based on clicks on the advertiser’s ad that are displayed on the websites of these distribution network partners. These payments are called traffic acquisition costs (“TAC”) and are included in cost of revenue. The revenue derived from these arrangements that involve traffic supplied by distribution network partners is reported gross of the payment to the distribution network partners. This revenue is reported gross due to the fact that we are the primary obligor to the advertisers who are the customers of the advertising service.

We also enter into agreements to provide private-labeled versions of our products, including licenses to the AdCenter platform technology. These license arrangements may include some or all of the following elements: revenue-sharing based on the publisher’s customers monthly revenue generated through the AdCenter application; upfront fees; minimum monthly fees; and other license fees. We recognize upfront fees over the term of the arrangement or the expected period of performance, other license fees over the term of the license, and revenue-sharing portions over the period in which such revenue is earned. In all cases, revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectability of the resulting receivable is reasonably assured.

We provide a provision against revenue for estimated reductions resulting from billing adjustments and customer refunds. The amounts of these provisions are evaluated periodically based upon customer experience and historical trends.

Deferred revenue is recorded when payments are received in advance of performance in underlying agreements. Customer deposits are recorded when customers make prepayments for online advertising.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from customers failing to make required payments. This valuation allowance is reviewed on a periodic basis to determine whether a provision or reversal is required. The review is based on factors including the application of historical collection rates to current receivables and economic conditions. We will record an increase or reduction of the allowance for doubtful accounts if collection rates or economic conditions are more or less favorable than we anticipated. Additional allowances for doubtful accounts may be required if there is deterioration in past due balances, if economic conditions are less favorable than we anticipated or for customer-specific circumstances, such as bankruptcy.

Concentrations, Credit Risk and Credit Risk Evaluation

Concentration of Credit Risk

Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash equivalents, investments, and accounts receivable. As of December 31, 2010 and December 31, 2009, we placed our cash equivalents and investments 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 at times may exceed federally insured limits. We have not experienced any credit losses on these cash equivalents and investment accounts and do not believe we are exposed to any significant credit risk on these funds. The fair value of these accounts is subject to fluctuation based on market prices.

Credit Risk, Customer and Vendor Evaluation

Accounts receivable are typically unsecured and are derived from sales to customers. We perform ongoing credit evaluations of our customers and maintain allowances for estimated credit losses. We apply judgment as to our ability to collect outstanding receivables based primarily on our evaluation of the customer’s financial condition and past collection history and record a specific allowance. In addition, we record an allowance based on the length of time the receivables are past due. Historically, such losses have been within our expectations.

 

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Revenue Concentrations

Our largest category of customers are a small number of intermediaries, one of which may represent 10% or more of revenue at any given time. These intermediaries purchase clicks to sell into the affiliate networks of the large search engine providers.

For the years ended December 31, 2010 and 2009, IAC Search and Media (“IAC”), accounted for 7% and 16%, respectively, of net revenue and 69% and 81%, respectively, of Publisher Solutions revenue. On May 19, 2009, IAC notified us that it did not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement, which provides for certain Publisher Solutions services (the “Agreement”) upon its expiration. The Agreement, as amended, was scheduled to expire by its terms on December 31, 2009, but was extended in one month intervals through October 31, 2010 and expired on that date. In addition, Advertiser Network revenue was derived from IAC under separate distribution agreements, accounting for 3% and 10% of Advertising Network revenue for the years ended December 31, 2010 and 2009, respectively, which were terminated in October 2010.

Impairment of Long-Lived Assets

We review long-lived assets held or used in operations, including property and equipment and internally developed software, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. Subject assets are tested for impairment at the lowest level of operations that generates cash flows that are largely independent of the cash flows from those of other groups of assets and liabilities. We have determined that the equity of our single reporting unit to be the lowest level of operation at which independent cash flows could be identified. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Impairment, if any, is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. Assets to be disposed of are reported at the lower of carrying amount or fair value less cost to dispose.

In 2009, purchased technology of $0.3 million was fully impaired because an associated initiative was discontinued.

As of December 31, 2010, there was no impairment of long-lived assets.

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.

When assets are retired or otherwise disposed of, the cost and accumulated depreciation and amortization are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in operating expenses. Maintenance and repairs are charged to expense as incurred. Expenditures that substantially increase an asset’s useful life are capitalized.

Internal Use Software Development Costs

We capitalize external direct costs of materials and services consumed in developing and obtaining internal-use computer software and the payroll and payroll-related costs of employees who devote time to developing internal-use computer software.

 

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We exercise judgment in determining when costs related to a project may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the amortization period for the capitalized costs, which is generally 3 years. We expect to continue to invest in internally developed software and to capitalize such costs.

Restructuring Charges

We have recorded restructuring charges related to closing of certain leased facilities and severance costs related to workforce reductions. Our judgment is required when estimating when the redundant facilities will be subleased and at what rate they will be subleased.

Traffic Acquisition Costs

We enter into agreements of varying durations with our distribution network partners that display our listings ads on their sites in return for a percentage of the revenue-per-click that we receive when the ads are clicked on those partners’ sites.

We also enter into agreements of varying durations with third party affiliates. These affiliate agreements provide for variable payments based on a percentage of our revenue or based on a certain metric, such as number of searches or paid clicks.

TAC expense is recorded in cost of revenue, and is based on a percentage of revenue.

Advertising Costs

Advertising costs are charged to sales and marketing expenses as incurred.

Product Development Costs

Research and development of new product ideas and enhancements to existing products are charged to expense as incurred.

Share-Based Compensation

We recognize share-based compensation costs for all share-based payment transactions, including grants of stock options and employee stock purchases related to the Employee Stock Purchase Plan, over the requisite service period based on their relative fair values. We estimate the fair value of share-based payment awards on the grant date using the Black-Scholes method. The value of the portion of the award that is ultimately expected to vest is recognized as expense in our Consolidated Statement of Operations over the requisite service periods.

Forfeitures are estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is determined at the end of each fiscal quarter, based on historical rates.

We elected to adopt the alternative transition method for calculating the tax effects of share-based compensation to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and the Consolidated Statement of Cash Flows of the tax effects of employee share-based compensation awards.

Income Taxes

We account for income taxes using the liability method. Under the liability method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation

 

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allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. We record liabilities, where appropriate, for all uncertain income tax positions. We recognize potential accrued interest and penalties related to unrecognized tax benefits within operations as income tax expense.

Recent Accounting Pronouncements

For a description of recent accounting pronouncements, see Note 1 to the Consolidated Financial Statements, Summary of Significant Accounting Policies.

RESULTS OF OPERATIONS

Overview of 2010

The following table sets forth selected information concerning our results of operations as a percentage of consolidated net revenue for the years ended December 31, 2010 and 2009.

 

     Year Ended December 31,  
     2010     % of
Revenue
    2009     % of
Revenue
    Dollar
Change
    %
Change
 

Revenue

   $ 47,479        100.0   $ 51,776        100.0   $ (4,297     (8 %) 

Cost of revenue

     28,832        60.7     33,351        64.4     (4,519     (14 %) 
                                          

Gross profit

     18,647        39.3     18,425        35.6     222        1
                                          

Operating expenses:

            

Sales and marketing

     4,331        9.1     5,617        10.8     (1,286     (23 %) 

Product development and technical operations

     9,039        19.0     9,831        19.0     (792     (8 %) 

General and administrative

     4,635        9.8     9,056        17.5     (4,421     (49 %) 

Restructuring charge

     —          0.0     536        1.0     (536     (100 %) 

Impairment charge

     —          0.0     280        0.5     (280     (100 %) 
                                          

Total operating expenses

     18,005        37.9     25,320        48.8     (7,315     (29 %) 
                                          

Income (loss) from operations

     642        1.4     (6,895     (13.2 %)      7,537        (109 %) 

Non-operating income (expense), net

     (20     (0.1 %)      59        0.0     (79     (134 %) 
                                          

Income (loss) from continuing operations before income taxes

     622        1.3     (6,836     (13.2 %)      7,458        (109 %) 

Income tax (expense) benefit

     (5     0.0     170        0.3     (175     (103 %) 
                                          

Income (loss) from continuing operations

     617        1.3     (6,666     (12.9 %)      7,283        (109 %) 

Income from discontinued operations

     358        0.8     464        0.9     (106     (23 %) 
                                          

Net income (loss)

   $ 975        2.1   $ (6,202     (12.0 %)    $ 7,177        (116 %) 
                                          

During 2010, revenue decreased 8%, gross profit margin increased four percentage points and operating expenses, excluding impairment and restructuring charges, decreased 27% from 2009, resulting in a 1% increase in gross profit and net income of $1.0 million. The improvement of approximately $7.2 million from the net loss of $6.2 million in 2009 is primarily due to reductions in TAC as a percentage of revenue and operating expenses.

The following developments during 2010 were key to our business performance:

 

  ·  

Return to Profitability: In the second quarter of 2010, the Company returned to profitability attributed to an increased focus on lowering TAC while increasing traffic quality resulting in higher gross margin combined with operating cost reducing initiatives.

 

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  ·  

Upgrades to Platform: In July 2010, the Company released an important upgrade to the Platform that included real-time click quality scoring that allows further optimization of the traffic delivered to advertisers enabling them to better meet performance metrics.

 

  ·  

Yahoo!-Bing Search Alliance: The Yahoo!-Bing Search Alliance integration that was implemented in the fourth quarter of 2010 had a negative impact on our Advertiser Networks revenue. Yahoo! partners are our largest customer group, and all partners were affected by significantly lower revenue-per-click (“RPC”) following the integration that led to reduced payments and consequently lower revenues.

 

  ·  

New Pricing Models: In the fourth quarter of 2010 the Company launched new pricing models that received positive initial response from its direct customer base.

 

  ·  

Quality Manifesto: In November 2010 the Company launched the Quality Manifesto, a commitment to advertisers and publishers to advance the standards of traffic quality and performance in an effort to deliver superior results.

 

  ·  

Completed Move into New Corporate Headquarter: In November 2009, the Company relocated to its new headquarters realizing annualized cost savings of approximately $2.0 million.

 

  ·  

Completed Transition into New Data Center Agreement Realizing Cost Savings: In May 2010, the Company completed the transition to its new data center facility realizing annualized cost savings of approximately $0.5 million.

Revenue

Revenue is derived from our two service offerings or “products”: Advertiser Networks and Publisher Solutions. Total revenue and revenue from Advertiser Networks and Publisher Solutions for the years ended December 31, 2010 and 2009, were as follows (in thousands):

 

     Year Ended December 31,  
     2010      % of
Revenue
    2009      % of
Revenue
    Dollar
Change
    %
Change
 

Advertiser Networks

   $ 44,373         93   $ 47,735         92   $ (3,362     (7 %) 

Publisher Solutions

     3,106         7     4,041         8     (935     (23 %) 
                                            

Total revenue

   $ 47,479         100   $ 51,776         100   $ (4,297     (8 %) 
                                            

The Advertiser Networks saw a reduction in paid clicks for the year ended December 31, 2010. Total paid clicks for the year ended December 31, 2010 decreased 11% to 755 million compared to 853 million for the same period in 2009. During the same period, average RPC increased 5%, from $0.056 to $0.059. Both of these changes were the result of customer mix in the comparable periods.

The decrease in Publisher Solutions revenue is attributed to decreased revenue from IAC Search and Media, Inc. (“IAC”), partially offset by increased revenue from other customers. During the year ended December 31, 2010, IAC represented $2.1 million, or 69%, of Publisher Solutions revenue compared to $3.3 million, or 81%, during the comparable period of 2009.

We continue to be dependent upon a few customers for a significant percentage of our revenue. For the year ended December 31, 2010, our overall revenue was concentrated with two customers that combined to account for 25% of net revenue. For the year ended December 31, 2009, two customers combined to account for 25% of revenue. One of the two significant 2009 customers, IAC, notified us in May 2009, that it did not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement, which provides for certain Publisher Solutions services (the “Agreement”) upon its expiration. The Agreement, as amended, was scheduled to expire by its terms on December 31, 2009, but was extended in one month intervals until October 31, 2010 and expired on that date.

Advertiser Network revenue derived from IAC, which was covered under separate distribution agreements, was $1.2 million and $4.9 million during the years ended December 31, 2010 and 2009, respectively. These agreements were terminated in October 2010.

 

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Cost of Revenue and Gross Profit

Cost of revenue consists of traffic acquisition costs (“TAC”), costs paid to our distribution network partners, colocation costs, commissions paid to advertising agencies, and credit card fees for the years ended December 31, 2010 and 2009, and were as follows (in thousands):

 

     Year Ended December 31,  
     2010      % of
Revenue
    2009      % of
Revenue
    Dollar
Change
    %
Change
 

Traffic acquisition costs

   $ 26,836         57   $ 31,178         60   $ (4,342     (14 %) 

Other costs

     1,996         4     2,173         4     (177     (8 %) 
                                            

Total cost of revenue

   $ 28,832         61   $ 33,351         64   $ (4,519     (14 %) 
                                            

Traffic acquisition costs as percentage of Advertiser Network revenue

        60        65    

Our TAC decrease as a percentage of associated revenue in 2010 is attributed 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 cost savings resulting from our move of co-location facilities, partially offset by significant duplicate costs incurred during the first half of the year associated with the co-location move itself.

Operating Expenses

Operating expenses consist of sales and marketing, product development and technical operations, general and administrative, restructuring charges, and impairment charges for the years ended December 31, 2010 and 2009, and were as follows (in thousands):

 

     Year Ended December 31,  
     2010      % of
Revenue
    2009      % of
Revenue
    Dollar
Change
    %
Change
 

Sales and marketing

   $ 4,331         9   $ 5,617         11   $ (1,286     (23 %) 

Product development and technical operations

     9,039         19     9,831         19     (792     (8 %) 

General and administrative

     4,635         10     9,056         17     (4,421     (49 %) 

Restructuring charge

     —           0     536         1     (536     (100 %) 

Impairment charge

     —           0     280         1     (280     (100 %) 
                                            

Total operating expenses

   $ 18,005         38   $ 25,320         49   $ (7,315     (29 %) 
                                            

Share-based compensation expense for the years ended December 31, 2010 and 2009 was allocated as follows (in thousands):

 

     Year Ended
December 31,
 
     2010      2009  

Sales and marketing

   $ 69       $ 141   

Product development and technical operations

     322         533   

General and administrative

     288         943   
                 

Total share-based compensation expense

     679         1,617   

Amounts capitalized as software development costs

     41         74   
                 

Total share-based compensation

   $ 720       $ 1,691   
                 

 

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Sales and Marketing

Sales and marketing expenses include salaries, commissions, share-based compensation and other costs of employment for our sales force, sales administration and customer service staff and marketing personnel, overhead, facilities, allocation of depreciation and the provision for and reductions of the allowance for doubtful trade receivables. Sales and marketing expenses also include the costs of advertising, trade shows, public relations activities and various other activities supporting our customer acquisition efforts.

The reduction in sales and marketing expenses for the year is primarily due to lower compensation related expense associated with lower headcount, a decrease in facilities costs attributed to our new headquarters, and a reduction in consulting and professional services.

Product Development and Technical Operations

Product development and technical operations expense includes all costs related to the continued operations, development and enhancement of our core technology product, the AdCenter platform. The AdCenter is used to operate both our own Advertiser Network and other publishers’ client networks, and is licensed to publishers to operate their own network. These costs include salaries and associated costs of employment, including share-based compensation, overhead, and facilities. Costs related to the development of software for internal use in the business, including salaries and associated costs of employment are capitalized after certain milestones have been achieved and amortized over a three year period once the project is placed in service. Software licensing and computer equipment depreciation related to supporting product development and technical operations functions are also included in product development and technical operations expense.

Capitalized software development costs include the costs to develop software for internal use, excluding costs associated with research, training and testing.

Product development and technical operations and capitalized software development costs for the years ended December 31, 2010 and 2009 were as follows (in thousands):

 

    Year Ended December 31,  
    2010     % of
Revenue
    2009     % of
Revenue
    Dollar
Change
    %
Change
 

Product development and technical operations costs

  $ 9,746        20   $ 10,975        21   $ (1,229     (11 %) 

Capitalized software development costs

    (707     (1 %)      (1,144     (2 %)      437        (38 %) 
                                         

Total product development and technical operations expense

  $ 9,039        19   $ 9,831        19   $ (792     (8 %) 
                                         

The reduction in product development and technical operations expense, net of capitalized software development costs for the year ended December 31, 2010 compared to the same period in 2009, is primarily due to lower facilities costs attributed to our new headquarters and lower compensation related expense associated with lower headcount, which was offset by lower capitalized software development and increased amortization expense.

General and Administrative

General and administrative expenses include costs of executive management, human resources, finance, and facilities personnel. These costs include salaries and associated costs of employment, including share-based compensation, overhead, facilities and allocation of depreciation. General and administrative expenses also include legal, insurance, tax and accounting, consulting and professional services fees.

 

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The reduction in general and administrative expenses for the year ended December 31, 2010 compared to the same period in 2009, is due to lower staffing-related and temporary help costs, including share-based compensation, of $1.8 million and $1.2 million of expenses in 2009 related to the evaluation of strategic growth alternatives that did not recur in 2010, combined with lower facilities costs attributed to our new headquarters and reduced legal and audit expenses.

Other items

The table below sets forth other continuing operations data for the years ended December 31, 2010 and 2009 (in thousands):

 

     Year Ended December 31,  
     2010     % of
Revenue
    2009     % of
Revenue
    Dollar
Change
    %
Change
 

Non-operating income (expense), net

            

Interest income

   $ 68        0   $ 234        0   $ (166     (71 %) 

Interest expense

     (148     0     (158     0     10        (6 %) 

Other income, net

     60        0     (17     0     77        (453 %) 
                                          

Total non-operating income (expense), net

   $ (20     0   $ 59        0   $ (79     (134 %) 
                                          

Income tax (expense) benefit

   $ (5     0   $ 170        0   $ (175     (103 %) 
                                          

Interest Income and Expense

Interest income, which includes income from our cash, cash equivalents and investments, decreased $0.2 million in the year ended December 31, 2010 from the year ended December 31, 2009. This decrease was driven by a decrease in the average cash and investment balances and average yields earned during the period.

Interest expense, primarily consisting of interest paid on capital leases, remained consistent during 2010 as compared to 2009.

Income Tax Expense

Due to our utilizable net operating losses and other tax affects, our income tax expense primarily consists of minimum state taxes.

Income from Discontinued Operations, Net of tax

In the first quarter of 2008, the Company’s management made the decision to exit the remaining consumer products activities and to sell or otherwise dispose of its remaining consumer assets. The various remaining related websites and assets associated with the consumer products activities met the criteria to be classified as discontinued operations. The results of operations related to assets to be disposed of, and of previously disposed assets, including any related gains and losses are classified as discontinued operations in the accompanying Consolidated Statements of Operations.

Income from discontinued operations, net of tax, for the years ended December 31, 2010 and 2009 was as follows (in thousands):

 

     Year Ended December 31,  
     2010      % of
Revenue
    2009      % of
Revenue
    Dollar
Change
    %
Change
 

Income from discontinued operations, net of tax

   $ 358         1   $ 464         1   $ (106     (23 %) 

 

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The following table reflects revenue, gross profit, operating expenses, gain on disposal, and net income from discontinued operations for the years ended December 31, 2010 and 2009 (in thousands):

 

     Year Ended
December 31,
 
     2010      2009  

Revenue

   $ —         $ 8   
                 

Gross profit

   $ —         $ 8   

Product development and technical operations

     —           (37

Gain on disposal

     358         493   
                 

Net income from discontinued operations

   $ 358       $ 464   
                 

As a result of our decision in early 2008 to dispose of our consumer assets, the Furl assets, consisting of property and equipment, capitalized software, goodwill and intangibles were accounted for as “assets held for sale.” Later in 2008, we determined that the Furl assets were impaired and recognized an impairment charge of $1.4 million. In February 2009, we sold the Furl assets and received a warrant to purchase 1.3 million shares of the acquirer’s non-marketable common stock at an exercise price of $0.30 per share (in each case, subject to certain adjustments in certain circumstances). We determined the warrants received had no significant value and did not record a gain on the disposal. The warrant expired unexercised in February 2010.

In January 2007, we completed the sale of Net Nanny to Content Watch, Inc. (“Content Watch”). The sale proceeds were comprised of contingent purchase consideration that may be realized at future dates based on the amount of revenue received by Content Watch. We recorded contingent purchase consideration of $0.4 million and $0.5 million for the years ended December 31, 2010 and 2009, respectively. Under the terms of the Content Watch agreement, the contingent purchase consideration ended December 31, 2010. Contingent purchase consideration has been classified as gain on disposal.

During 2008, we sold the Wisenut trademark and related domain names. As of December 31, 2010 and 2009, we continue to own the Wisenut search engine technology and its intellectual property rights in such technology and other assets.

Liquidity and Capital Resources

Cash flows were as follows (in thousands):

 

     Year Ended December 31,  
     2010     2009     Change  

Net cash provided by (used in) operating activities

   $ 2,605      $ (3,023   $ 5,628   

Net cash provided by (used in) investing activities

     (2,041     4,655        (6,696

Net cash used in financing activities

     (1,378     (1,092     (286
                        

Increase (decrease) in cash and cash equivalents

   $ (814   $ 540      $ (1,354
                        

 

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Cash, cash equivalents and short- and long-term marketable investment balances were as follows as of December 31, 2010 and 2009 (in thousands):

 

     December 31,        
     2010     2009     Change  

Cash and cash equivalents

   $ 22,119      $ 22,933      $ (814

Short-term investments

     3,250        4,780        (1,530

Long-term investments

     1,577        —          1,577   
                        

Total

   $ 26,946      $ 27,713      $ (767
                        

% of total assets

     75     72  
                  

Total assets

   $ 35,725      $ 38,347     
                  

At December 31, 2010, we had $26.9 million of cash, cash equivalents and short- and long-term marketable investments. Cash equivalents and short- and long-term marketable investments are comprised of highly liquid debt instruments of the U.S. government, commercial paper, time deposits, money market mutual funds and U.S. corporate securities. We actively monitor the depository institutions that hold our cash and cash equivalents and the institutions of whose debt instruments we hold. Our investment policy, which is reviewed annually by our Board of Directors, primarily emphasizes safety of principal while secondarily on maximizing yield on those funds. We can provide no assurances that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial markets. These balances may exceed the Federal Deposit Insurance Corporation insurance limits. While we monitor the cash balances in our operating accounts and adjust the cash balances as appropriate, these cash balances could be impacted if the underlying financial institutions fail or could be subject to other adverse conditions in the financial markets. See Note 3 to the Consolidated Financial Statements, “Cash and Available for Sale Securities,” which describes further the composition of our cash, cash equivalents and short- and long-term investments.

Cash, cash equivalents and short- and long-term investments decreased $0.8 million in 2010 primarily due to the purchase of property and equipment, payments of capital lease obligations and the decrease of working capital offset by our positive operating cash flow.

Our primary source of liquidity is our cash, cash equivalents, short- and long-term investments, and cash flow from operations. We believe that our existing cash, cash equivalents, short- and long-term investments and cash from operations will be sufficient to satisfy our current anticipated cash requirements through at least the next 12 months, if not longer. Our liquidity could be negatively affected by a decrease in demand for our services beyond the current quarter, and changes in customer buying behavior. In addition, our liquidity could be negatively affected if we are in default under our credit facilities and are required to pay the lenders cash in an amount equal to the capital lease balance, or are required to identify restricted cash equal to the capital lease balance, plus an outstanding standby letter of credit. Also, if the banking system or the financial markets continue to remain volatile, our investment portfolio may be impacted and the values and liquidity of our investments could be adversely affected. In addition, we may seek to raise additional capital through public or private debt or equity financings in order to fund our operations and capital expenditures, take advantage of favorable business opportunities, develop and upgrade our technology infrastructure, develop new product and service offerings, take advantage of favorable conditions in capital markets or respond to competitive pressures. In addition, unanticipated developments in the short term requiring cash payments, including the acquisition of businesses with negative cash flows, may necessitate additional financing. We cannot be assured that additional financing will be available on terms favorable to us, or at all. If we issue additional equity or convertible debt securities, our existing stockholders may experience substantial dilution.

 

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Operating Activities

Cash provided by operating activities in the year ended December 31, 2010 consisted of our net income adjusted for certain non-cash items, including depreciation, amortization, share-based compensation expense, gains on sale of assets, as well as the effect of changes in working capital and other activities. Cash provided by operations in the year ended December 31, 2010 was $2.6 million and consisted of a net income of $1.0 million, adjustments for non-cash items of $3.3 million and cash used by working capital and other activities of $1.6 million. Adjustments for non-cash items primarily consisted of $2.9 million of depreciation and amortization expense on property and equipment and internally developed software and $0.7 million of share-based compensation expense, partially offset by a $0.4 million gain on sale of assets. In addition, changes in working capital activities primarily consisted of a $2.3 million decrease in accounts payable and accrued liabilities, partially offset by a net decrease of $0.7 million in accounts receivable. The decrease in accounts payable and accrued liabilities was primarily due to reduced TAC and operating expenses. The decrease in account receivable is primarily attributed to a decrease in invoiced customer revenue.

Cash used in operating activities in the year ended December 31, 2009 consisted of our net loss adjusted for certain non-cash items, including depreciation, amortization, share-based compensation expense, impairment charge, as well as the effect of changes in working capital and other activities. Cash used in operations in the year ended December 31, 2009 was $3.0 million and consisted of a net loss of $6.2 million, adjustments for non-cash items of $4.4 million and cash used by working capital and other activities of $1.3 million. Adjustments for non-cash items primarily consisted of $2.9 million of depreciation and amortization expense on property and equipment, intangible assets and internally developed software, $1.6 million of share-based compensation expense and a $0.3 impairment charge, partially offset by a $0.4 million gain on sale of assets. In addition, changes in working capital activities primarily consisted of a net decrease of $3.3 million in accounts payable and accrued liabilities and a $1.6 million decrease in deferred revenue and customer deposits and other long term liabilities, partially offset by a $2.9 million decrease in accounts receivable and a $0.7 million in prepaid expenses and other current assets. The decrease in accounts payable and accrued liabilities is due to the timing of vendor payments combined with the payment of an indemnification settlement and its related legal costs of $1.1 million that were accrued in 2008 but paid in 2009. The decrease in accounts receivable is attributed to more revenue from credit card customers as compared to the previous year and successful collection efforts.

Investing Activities

Cash used in investing activities during the year ended December 31, 2010 of $2.0 million was primarily attributed to $2.4 million of capital expenditures, partially offset by $0.4 million of proceeds related to the sale of certain consumer assets. Capital expenditures for the year ended December 31, 2010 consisted of $0.8 million for equipment received in 2009, for which a liability was accrued in 2009, $0.9 million for equipment acquired during 2010, and an investment of $0.7 million in internally developed software related to our AdCenter platform technology.

Cash provided by investing activities during the year ended December 31, 2009, of $4.7 million is attributed to net proceeds of investments of $5.4 million and $0.5 million of proceeds related to the sale of certain consumer assets, partially offset by $1.2 million of capital expenditures. Capital expenditures for the year ended December 31, 2009 consisted primarily of an investment of $1.1 million in internally developed software related to our core service offering. During the year ended December 31, 2009, most of our $1.4 million investment in computer equipment was financed with capital leases.

Financing Activities

Cash used by financing activities in the year ended December 31, 2010 of $1.4 million is attributed to scheduled capital lease payments.

 

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Cash used by financing activities in the year ended December 31, 2009 of $1.1 million is attributed to scheduled capital lease and note payable payments.

Credit Arrangements

We have an outstanding standby letter of credit (“SBLC”) issued by City National Bank (“CNB”) of approximately $0.3 million at December 31, 2010, related to security of a building lease.

On April 30, 2010, our master equipment lease agreement with CNB of $5.0 million expired. As of April 30, 2010, we had drawn down approximately $4.9 million of the available lease line of credit.

Our agreements with CNB, consisting of the SBLC and master equipment lease agreement, contain cross-default provisions whereby a default under one is deemed a default for the other, and are secured by a general lien on all assets of the Company. As of December 31, 2010, we are in compliance with both agreements with CNB.

In December 2009, we entered into an Agreement to Lease Equipment (“Lease Agreement”) with Cisco Systems Capital Corporation (“Cisco”), whereby we were to lease from Cisco certain hardware, software and maintenance services. The Lease Agreement provided for the lease of $0.8 million of hardware and software and $0.2 million of maintenance services over a period of three years. In connection with the Lease Agreement, we provided Cisco a SBLC for $0.2 million. As of December 31, 2009, $0.5 million of the equipment and software had been received and is included in property and equipment with an offsetting amount in accrued liabilities in the Consolidated Balance Sheets. In March 2010, we decided, and Cisco agreed, to cancel the Lease Agreement, and we paid the vendor $1.0 million for the hardware, software and maintenance services. No additional costs will be incurred by the Company. The SBLC provided to Cisco for $0.2 million was released by Cisco and terminated in May 2010.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements as defined in Regulation S-K Item 303(a)(4), investments in special-purpose entities or undisclosed borrowings or debt. Additionally, we are not a party to any derivative contracts or synthetic leases.

Contractual Obligations and Commercial Commitments

We incur various contractual obligations and commercial commitments in our normal course of business. The following table summarizes our significant contractual obligations and commercial commitments as of December 31, 2010, and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in thousands):

 

    Total     Less than
1 year
    1-3
years
    3-5
years
    Thereafter  

Operating lease obligations

  $ 2,202      $ 592      $ 1,053      $ 557      $ —     

Capital lease obligations (principal and interest)

    1,882        1,120        762        —          —     

Purchase obligations

    1,083        1,008        75        —          —     
                                       
  $ 5,167      $ 2,720      $ 1,890      $ 557      $ —     
                                       

Operating Leases

On August 31, 2009, we entered into an agreement to sublease office space for our headquarters in San Francisco, California, that expires in December 2014. In addition to scheduled base rent payments, we will also be responsible for varying amounts of operating and tax expenses. These operating expenses are not included in the table above.

 

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Capital Leases

We have acquired various computer equipment under capital leases with terms from 36 to 42 months.

Purchase Obligations

Purchase obligations represent an open purchase order for which we have not received the related goods totaling $0.1 million, and a non-cancelable contractual obligation at December 31, 2010. Our non-cancelable contractual obligation is related to data center operations.

In October 2009, we entered into a Master Services Agreement and related Service Level Agreement for IT data center services for a two year term, expiring January 2012. Our contractual obligations under the agreement include recurring charges of $0.9 million each year.

Indemnification

We have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was, serving, at our request, in such capacity, to the maximum extent permitted under the laws of the State of Delaware. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. However, we maintain 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. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal. Historically, we have not incurred any losses or recorded any liabilities related to performance under these types of indemnities.

Additionally, in the normal course of business, we have made certain guarantees, indemnities and commitments under which we may be required to make payments in relation to certain transactions. These indemnities include intellectual property and other indemnities to our customers and distribution network partners in connection with the sales of our products, and indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease. In some cases, we have obtained insurance providing coverage for loses such as these. The maximum potential amount of future payments we could be required to make under these indemnification provisions is generally limited. Notwithstanding the foregoing, the maximum potential liability for any such claim or claims for indemnification is uncertain based on the unique nature of each arrangement. Management believes the estimated fair value of these obligations is minimal. Accordingly, we have no liabilities recorded for these agreements as of December 31, 2010.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO THE FINANCIAL STATEMENTS

LOOKSMART, LTD

 

     Page  

Report of Independent Registered Public Accounting Firm

     38   

Consolidated Balance Sheets at December 31, 2010 and 2009

     39   

Consolidated Statements of Operations for the years ended December 31, 2010 and 2009

     40   

Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2010 and 2009

     41   

Consolidated Statements of Cash Flows for the years ended December 31, 2010 and 2009

     42   

Notes to Consolidated Financial Statements

     43   

 

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Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of

Looksmart, Ltd.

We have audited the accompanying consolidated balance sheets of Looksmart, Ltd (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.

We conducted our audits in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Looksmart, Ltd. as of December 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ Moss Adams LLP

San Francisco, California

February 25, 2011

 

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LOOKSMART, LTD.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

 

     December 31,  
     2010     2009  

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 22,119      $ 22,933   

Short-term investments

     3,250        4,780   
                

Total cash, cash equivalents and short-term investments

     25,369        27,713   

Trade accounts receivable, net

     3,267        3,990   

Prepaid expenses and other current assets

     680        847   
                

Total current assets

     29,316        32,550   

Long-term investments

     1,577        —     

Property and equipment, net

     3,082        3,717   

Capitalized software and other assets, net

     1,750        2,080   
                

Total assets

   $ 35,725      $ 38,347   
                

LIABILITIES & STOCKHOLDERS’ EQUITY

    

Current liabilities:

    

Trade accounts payable

   $ 2,503      $ 2,918   

Accrued liabilities

     2,615        5,477   

Deferred revenue and customer deposits

     1,004        1,113   

Current portion of capital lease obligations

     1,048        1,272   
                

Total current liabilities

     7,170        10,780   

Capital lease and other obligations, net of current portion

     902        1,646   
                

Total liabilities

     8,072        12,426   
                

Commitment and contingencies

    

Stockholders’ equity:

    

Convertible preferred stock, $0.001 par value; Authorized: 5,000 shares at December 31, 2010 and 2009; Issued and Outstanding: none at December 31, 2010 and 2009

     —          —     

Common stock, $0.001 par value; Authorized: 80,000 shares and 200,000 shares at December 31, 2010 and 2009, respectively; Issued and Outstanding: 17,222 shares and 17,145 shares at December 31, 2010 and 2009, respectively

     17        17   

Additional paid-in capital

     261,740        260,981   

Accumulated other comprehensive gain

     1        3   

Accumulated deficit

     (234,105     (235,080
                

Total stockholders’ equity

     27,653        25,921   
                

Total liabilities and stockholders’ equity

   $ 35,725      $ 38,347   
                

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

 

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LOOKSMART, LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

 

     Year Ended December 31,  
           2010                 2009        

Revenue

   $ 47,479      $ 51,776   

Cost of revenue

     28,832        33,351   
                

Gross profit

     18,647        18,425   
                

Operating expenses:

    

Sales and marketing

     4,331        5,617   

Product development and technical operations

     9,039        9,831   

General and administrative

     4,635        9,056   

Restructuring charge

     —          536   

Impairment charge

     —          280   
                

Total operating expenses

     18,005        25,320   
                

Income (loss) from operations

     642        (6,895

Non-operating income (expense), net

    

Interest income

     68        234   

Interest expense

     (148     (158

Other income (expense), net

     60        (17
                

Income (loss) from continuing operations before income taxes

     622        (6,836

Income tax (expense) benefit

     (5     170   
                

Income (loss) from continuing operations

     617        (6,666

Income from discontinued operations, net of tax

     358        464   
                

Net income (loss)

   $ 975      $ (6,202
                

Net income (loss) per share—Basic and Diluted

    

Income (loss) from continuing operations

   $ 0.04      $ (0.39

Income from discontinued operations, net of tax

     0.02        0.03   
                

Net income (loss) per share—Basic and Diluted

   $ 0.06      $ (0.36
                

Weighted average shares outstanding used in computing basic net income (loss) per share

     17,179        17,108   
                

Weighted average shares outstanding used in computing diluted net income (loss) per share

     17,236        17,108   
                

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

 

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LOOKSMART, LTD.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

 

    Common Stock     Additional
Paid-in
Capital
    Accumulated
Other
Comprehensive
Gain (Loss)
    Accumulated
Deficit
    Total
Stockholders’
Equity
    Comprehensive
Income (Loss)
 
    Shares     Amount                                

Balance at December 31, 2008

    17,075      $ 17      $ 259,276      $ (4   $ (228,878   $ 30,411      $ (14,850
                   

Common stock issued for employee stock purchase plan

    12        —          14        —          —          14     

Issuance of restricted stock

    58        —          63        —          —          63     

Share-based compensation

    —          —          1,628        —          —          1,628     

Comprehensive loss:

             

Unrealized gain on securities, net

    —          —          —          7        —          7      $ 7   

Net loss

    —          —          —          —          (6,202     (6,202     (6,202
                                                       

Balance at December 31, 2009

    17,145      $ 17      $ 260,981      $ 3      $ (235,080   $ 25,921      $ (6,195
                   

Common stock issued upon exercise of stock option

    1        —          1        —          —          1     

Common stock issued for employee stock purchase plan

    41        —          38        —          —          38     

Issuance of restricted stock

    35        —          46        —          —          46     

Share-based compensation

    —          —          674        —          —          674     

Comprehensive income:

             

Unrealized loss on securities, net

    —          —          —          (2     —          (2   $ (2

Net income

    —          —          —          —          975        975        975   
                                                       

Balance at December 31, 2010

    17,222      $ 17      $ 261,740      $ 1      $ (234,105   $ 27,653      $ 973   
                                                       

 

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

 

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LOOKSMART, LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Year Ended
December 31,
 
     2010     2009  

Cash flows from operating activities:

    

Net income (loss)

   $ 975      $ (6,202

Adjustment to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Depreciation and amortization

     2,897        2,888   

Share-based compensation

     679        1,617   

Impairment charge

     —          280   

Gain from sale of assets and other non-cash charges

     (411     (424

Deferred rent expense

     86        80   

Changes in operating assets and liabilities:

    

Trade accounts receivable

     728        2,935   

Prepaid expenses and other current assets

     103        733   

Trade accounts payable

     (415     (1,439

Accrued liabilities

     (1,928     (1,851

Deferred revenue and customer deposits

     (109     (480

Other long-term obligations

     —          (1,160
                

Net cash provided by (used in) operating activities

     2,605        (3,023
                

Cash flows from investing activities:

    

Purchase of investments

     (13,322     (15,217

Proceeds from sale of investments

     13,259        20,577   

Proceeds from sale of equipment

     71        —     

Payments for property, equipment, and capitalized software

     (2,402     (1,243

Proceeds from contingent purchase consideration of certain consumer assets

     353        538   
                

Net cash provided by (used) in investing activities

     (2,041     4,655   
                

Cash flows from financing activities:

    

Principal payments of notes

     —          (63

Principal payments of capital lease obligations

     (1,417     (1,043

Proceeds from issuance of common stock

     39        14   
                

Net cash used in financing activities

     (1,378     (1,092
                

Increase (decrease) in cash and cash equivalents

     (814     540   

Cash and cash equivalents, beginning of period

     22,933        22,393   
                

Cash and cash equivalents, end of period

   $ 22,119      $ 22,933   
                

Supplemental disclosure of cash flow information:

    

Interest paid

   $ 140      $ 152   

Income taxes paid

   $ 4      $ 6   

Supplemental disclosure of noncash activities:

    

Assets acquired through capital lease obligations

   $ 363      $ 1,635   

Property and equipment received and liability accrued

   $ —        $ 806   

Change in unrealized gain on investments

   $ (2   $ 7   

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

 

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LOOKSMART, LTD.

NOTES TO 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 (losses), have been classified as discontinued operations for all periods presented in the accompanying Consolidated Statements of Operations (see Note 2). At December 31, 2010, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology, and other assets.

Principles of Consolidation

The Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.

Use of Estimates and Assumptions

The 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

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

Reclassifications

Certain amounts in the financial statements for 2009 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 the Consolidated Statements of Stockholders’ Equity. The Company recognizes realized gains and losses upon sale of investments using the specific identification method.

Fair Value of Financial Instruments

The Company’s estimate of fair value for assets and liabilities is based on a framework that establishes a hierarchy of the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions. The three levels of the hierarchy are as follows:

 

  Level 1: Unadjusted quoted market prices for identical assets or liabilities in active markets that we have the ability to access.

 

  Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, default rates, etc.) or can be corroborated by observable market data.

 

  Level 3: Valuations based on models where significant inputs are not observable. The unobservable inputs reflect our assumptions about the assumptions that market participants would use.

Revenue Recognition

Online search advertising revenue is primarily composed of per transaction fees that the Company charges customers. Revenue also includes revenue share from licensing of private-labeled versions of the Company’s AdCenter Platform.

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 we are 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 receivables, net is $0.2 million and insignificant at December 31, 2010 and 2009, 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 and $0.1 million at December 31, 2010 and 2009, respectively. Bad debt expense (benefit) included in sales and marketing expense was not significant for the years ended December 31, 2010 and 2009.

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 December 31, 2010 and 2009, the Company placed its cash equivalents and investments primarily through one financial institution, City National Bank (“CNB”), and mitigated the concentration of credit risk by placing percentage limits on the maximum portion of the investment portfolio which may be invested in any one investment instrument. These amounts exceed

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

federally insured limits at December 31, 2010 and 2009. The Company has not experienced any credit losses on these cash equivalents and investment accounts and does not believe it is exposed to any significant credit risk on these funds. The fair value of these accounts is subject to fluctuation based on market prices.

Credit Risk, Customer and Vendor Evaluation

Accounts receivable are typically unsecured and are derived from sales to customers. The Company performs ongoing credit evaluations of its customers and maintains allowances for estimated credit losses. The Company applies judgment as to its ability to collect outstanding receivables based primarily on management’s evaluation of the customer’s financial condition and past collection history and records a specific allowance. In addition, the Company records an allowance based on the length of time the receivables are past due. Historically, such losses have been within management’s expectations.

The following table reflects customers that accounted for more than 10% of gross accounts receivable:

 

     December 31,  
     2010     2009  

Company 1

     *     16

Company 2

     21     *

 

** Less than 10%

Revenue Concentrations

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

 

     Year Ended
December 31,
 
     2010     2009  

United States

     60     86

Europe, Middle East and Africa

     27     *

Canada

     *     11

 

** 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:

 

     Year Ended
December 31,
 
     2010     2009  

Advertiser Networks

     93     92

Publisher Solutions

     7     8

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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

 

     Year Ended
December 31,
 
     2010     2009  

Company 1

     *     16

Company 2

     14     *

Company 3

     11     *

 

** Less than 10%

For the year ended December 31, 2010, IAC Search and Media (“IAC” or “Company 1”) accounted for 7% of net revenue, and 69% of Publisher Solutions revenue. For the year ended December 31, 2009, IAC accounted for 16% of net revenue, and 81% of Publisher Solutions revenue. On May 19, 2009, Ask Sponsored Listings, a division of IAC, notified the Company that it did not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement, which provides for certain Publisher Solutions services (the “Agreement”) upon its expiration. The Agreement, as amended, was scheduled to expire by its terms on December 31, 2009, but was extended in one month intervals through October 31, 2010 and expired on that date. In addition, Advertiser Network revenue derived from IAC under separate agreements, accounting for 3% and 10% of Advertising Network revenue for the years ended December 31, 2010 and 2009, respectively, were terminated in October 2010.

The Company derives its revenue primarily from its relationships with significant distribution network partners. The following table reflects the distribution partners that accounted for more than 10% of the total traffic acquisition costs (“TAC”):

 

     Year Ended
December 31,
 
     2010     2009  

Distribution Partner 1

     17     *

Distribution Partner 2

     *     11

Distribution Partner 3

     11     10

Distribution Partner 4

     *     11

Distribution Partner 5

     10     *

 

** 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.

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

When assets are retired or otherwise disposed of, the cost and accumulated depreciation and amortization are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in operating expenses. Maintenance and repairs are charged to expense as incurred. Expenditures that substantially increase an asset’s useful life are capitalized.

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.

Restructuring Charges

The Company has recorded restructuring charges related to closing of certain leased facilities and severance costs related to workforce reductions. Management’s judgment was required when estimating when the redundant facilities would be subleased and at what rate they will be subleased.

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.

In 2009, purchased technology of $0.3 million was fully impaired because an associated initiative was discontinued.

As of December 31, 2010, there was no impairment of long-lived assets.

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.

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 Consolidated Statements of Operations over the requisite service periods. Share-based compensation expense recognized for the years ended December 31, 2010 and 2009, were $0.7 million and $1.7 million, respectively, which was related to stock grants, options and employee stock purchases.

Forfeitures are estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is determined at the end of each fiscal quarter, based on historical rates.

Advertising Costs

Advertising costs are charged to sales and marketing expenses as incurred and amounted to $0.2 million for each of the years ended December 31, 2010 and 2009.

Product Development Costs

Research of new product ideas and enhancements to existing products are charged to expense as incurred. Costs related to the development of software for internal use, including salaries and associated costs of employment are capitalized after certain milestones have been achieved and amortized over a three year period once the project is placed in service.

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 (Loss)

Other comprehensive gain (loss) as of December 31, 2010 and 2009 consists of unrealized gains and losses on marketable securities categorized as available-for-sale.

Net Income (Loss) per Common Share

Basic net income (loss) and diluted net income (loss) per share is calculated using the weighted average shares of common stock outstanding. Diluted net income per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding during the period, using the treasury stock method for stock options and warrants.

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 December 31, 2010 and 2009, all of the Company’s accounts receivable, intangible assets, and deferred revenue related to the online advertising segment. All long-lived assets are located in the United States.

Recent Accounting Pronouncements

Effective January 1, 2010, the Company adopted the guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance also requires that an entity should provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. Therefore, the Company has not yet adopted the guidance with respect to the roll forward activity in Level 3 fair value measurements. The Company has updated its disclosures to comply with the updated guidance (see Note 10), however, adoption of the updated guidance did not have a material impact on the Company’s results of operations, financial position or liquidity.

 

2. Discontinued Operations and Dispositions

Foreign Operations

In 2004, the Company’s management made the decision to cease operating and liquidate its then existing foreign legal entities, and reclassified its consolidated financial statements to reflect these foreign entity expenses as discontinued operations. During the year ended December 31, 2009, the loss related to the liquidation of the Company’s foreign legal entities was not significant. The Company completed the dissolution of these entities in 2009. As of December 31, 2010 and 2009, there were no net assets related to the discontinued foreign legal entities.

Consumer Products

In the first quarter of 2008, the Company’s management made the decision to exit the remaining consumer products activities and to sell or otherwise dispose of its remaining consumer assets. The various remaining related websites and assets associated with the consumer products activities met the criteria to be classified as discontinued operations. The results of operations related to assets to be disposed of, and of previously disposed assets, including any related gains and losses are classified as discontinued operations in the accompanying Consolidated Statements of Operations.

As of December 31, 2010, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology and other assets.

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The following table reflects revenue, gross profit, operating expenses, gain on disposal and net income (loss) of discontinued operations for each of the years ended December 31, 2010 and 2009 (in thousands):

 

     Year Ended December 31,  
           2010                  2009        

Revenue

   $ —         $ 8   
                 

Gross profit

   $ —         $ 8   

Product development and technical operations

     —           (37

Gain on disposal

     358         493   
                 

Net income from discontinued operations

   $ 358       $ 464   
                 

Furl

In the first quarter of 2008, the Company’s management made the decision to exit the remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. As a result, beginning in the first quarter of 2008, Furl assets, consisting of property and equipment, capitalized software, goodwill and intangible assets, were accounted for as “assets held for sale.” In the fourth quarter of 2008, the Company determined that the Furl assets were fully impaired due to the lack of marketability and the decision to wind down the Furl operations. As a result, the Company recognized an impairment charge of $1.4 million during 2008. On February 26, 2009, the Company sold the Furl assets and received a warrant to purchase 1.3 million shares of the acquirer’s non-marketable common stock at an exercise price of $0.30 per share (in each case, subject to certain adjustments in certain circumstances). The Company determined the warrant received had no significant value and did not record a gain on the disposal. The Furl assets had no net book value. The warrant expired unexercised in February 2010.

Net Nanny

On January 22, 2007, the Company completed the sale of Net Nanny to Content Watch, Inc. (“Content Watch”). The sale proceeds were comprised of contingent purchase consideration that may be realized at future dates based on the amount of revenue received by Content Watch. The Company recorded contingent purchase consideration of $0.4 million and $0.5 million for the years ended December 31, 2010 and 2009, respectively. Under the terms of the Content Watch agreement, the contingent purchase consideration period ended December 31, 2010. Contingent purchase consideration has been classified as gain on disposal.

 

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3. Cash and Available-for-Sale Securities

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 December 31, 2010 and 2009 (in thousands):

 

     December 31  
     2010      2009  
     Amortized Cost
and Estimated
Fair Value
     Amortized Cost
and Estimated
Fair Value
 

Cash and cash equivalents:

     

Cash

   $ 9,435       $ 4,460   
                 

Cash equivalents

     

Money market mutual funds

     35         10,074   

Certificates of deposit

     2,000         2,000   

Commercial paper

     10,649         6,399   
                 

Total cash equivalents

     12,684         18,473   
                 

Total cash and cash equivalents

     22,119         22,933   
                 

Short-term investments:

     

Corporate bonds

     —           2,890   

Certificates of deposit

     2,250         490   

Commercial paper

     1,000         1,400   
                 

Total short-term investments

     3,250         4,780   
                 

Long-term investments:

     

Corporate bonds

     1,577         —     
                 

Total cash and available-for-sale securities

   $ 26,946       $ 27,713   
                 

Realized gains and realized losses were not significant for either of the years ended December 31, 2010 or 2009. As of December 31, 2010 and 2009, 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 December 31, 2010 were less than one year. The contractual maturity of the long term investments is 1.75 years (see Note 12).

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 years ended December 31, 2010 and 2009, the Company did not recognize any impairment charges on outstanding investments. As of December 31, 2010, the Company does not consider any of its investments to be other-than-temporarily impaired.

 

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4. Property and Equipment

Property and equipment consisted of the following at December 31, 2010 and 2009 (in thousands):

 

     December 31, 2010      December 31, 2009  
     Cost      Accumulated
Depreciation
    Net Book
Value
     Cost      Accumulated
Depreciation
    Net Book
Value
 

Computer equipment

   $ 9,224       $ (6,411   $ 2,813       $ 10,920       $ (7,516   $ 3,404   

Furniture and fixtures

     75         (59     16         74         (55     19   

Software

     1,239         (1,220     19         1,260         (1,247     13   

Leasehold improvements

     308         (74     234         288         (7     281   
                                                   

Total

   $ 10,846       $ (7,764   $ 3,082       $ 12,542       $ (8,825   $ 3,717   
                                                   

Depreciation expense on property and equipment for the years ended December 31, 2010 and 2009, including cost of property and equipment under capital lease, was $1.8 million and $1.9 million, respectively, and is recorded in operating expenses. Equipment under capital lease totaled $4.3 million and $4.4 million as of December 31, 2010 and 2009, respectively. Depreciation expense on equipment under capital lease was $1.3 million and $1.1 million for the years ended December 31, 2010 and 2009, respectively. Additionally, accumulated depreciation on equipment under capital lease was $2.8 million and $1.8 million as of December 31, 2010 and 2009, respectively.

 

5. Capitalized Software and Other Assets

The Company’s capitalized software and other assets are as follows at December 31, 2010 and 2009 (in thousands):

 

     December 31, 2010      December 31, 2009  
     Gross
Amount
     Accumulated
Amortization
    Net Book
Value
     Gross
Amount
     Accumulated
Amortization
    Net Book
Value
 

Capitalized software

   $ 6,206       $ (4,550   $ 1,656       $ 5,499       $ (3,449   $ 2,050   

Amortizable purchased technology

     78         (78     —           78         (78     —     

Other assets

     94         —          94         30         —          30   
                                                   
   $ 6,378       $ (4,628   $ 1,750       $ 5,607       $ (3,527   $ 2,080   
                                                   

Capitalized software consists of external direct costs of materials and services consumed in developing and obtaining internal-use computer software and the payroll and payroll-related costs for employees who are directly associated with and who devote time to developing the internal-use computer software and is amortized over three years. Amortization expense was $1.1 million and $1.0 million for the years ended December 31, 2010 and 2009, respectively.

In the year ended December 31, 2009, purchased technology of $0.3 million was fully impaired because an associated initiative was discontinued.

 

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6. Accrued Liabilities

Accrued liabilities consisted of the following as of December 31, 2010 and 2009 (in thousands):

 

     December 31,  
     2010      2009  

Accrued distribution and partner costs

   $ 1,473       $ 2,957   

Accrued compensation and related expenses

     513         839   

Accrued professional service fees

     222         376   

Accrued equipment purchases

     —           806   

Other

     407         499   
                 

Total accrued liabilities

   $ 2,615       $ 5,477   
                 

 

7. Restructuring Charges

In May 2009 and September 2009, the Company recorded $0.2 million and $0.3 million, respectively, in pre-tax restructuring charges associated with the termination of employees. All restructuring charges have been classified as such on the Consolidated Statement of Operations. The Company had no restructuring costs accrued at December 31, 2009.

Between 2003 and 2006, the Company vacated portions of its leased headquarter office facilities that expired in November 2009, incurring lease restructuring costs related to closing these facilities and entering into various subleases. During the year ended December 31, 2009, the Company amortized $1.2 million of accrued lease restructuring costs to operating expenses. The Company had no lease restructuring costs accrued at December 31, 2009.

 

8. Capital Lease and Other Obligations

Capital lease and other obligations consist of the following at December 31, 2010 and 2009 (in thousands):

 

     December 31,  
     2010     2009  

Capital lease obligations

   $ 1,784      $ 2,838   

Deferred rent

     166        80   
                

Total capital lease and other obligations

     1,950        2,918   

Less: current portion of capital lease obligations

     (1,048     (1,272
                

Capital lease and other obligations, net of current portion

   $ 902      $ 1,646   
                

Capital Lease Obligations

City National Bank (CNB)

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 was amended to modify two financial covenants, with which the Company was in compliance as of December 31, 2010.

 

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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 December 31, 2010 and 2009, the Company was not in default on either agreement with CNB (see Note 10).

Cisco Systems Capital Corporation

In December 2009, the Company entered into an Agreement to Lease Equipment (“Lease Agreement”) with Cisco Systems Capital Corporation (“Cisco”), whereby the Company was to lease from Cisco certain hardware, software and maintenance services. The Lease Agreement provided for the lease of $0.8 million of hardware and software and $0.2 million of maintenance services over a period of three years. In connection with the Lease Agreement, the Company provided Cisco a SBLC for $0.2 million. As of December 31, 2009, $0.5 million of the equipment and software had been received and is included in property and equipment with an offsetting amount in accrued liabilities in the Condensed Consolidated Financial Statements. In March 2010, prior to the commencement of the lease, the Company and Cisco agreed to cancel the Lease Agreement, and the Company paid the vendor $1.0 million for the hardware, software and maintenance services. No additional costs will be incurred by the Company. The SBLC provided to Cisco for $0.2 million was released by Cisco and terminated in May 2010.

 

9. Income Taxes

The Company accounts for uncertainty in tax positions and recognizes in its financial statements the largest amount of a tax position that is more-likely-than-not to be sustained upon audit, based on the technical merits of the position.

The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is no longer subject to U.S. federal tax examinations for years before 2007. The tax years that remain subject to examination in state jurisdictions range from 2006 to 2009. The Company believes that its income tax filing positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material adverse effect on the Company’s financial condition, results of operations, or cash flows. Therefore, no reserves for uncertain income tax positions have been recorded at December 31, 2010.

The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. The Company did not have any accrued interest or penalties associated with unrecognized tax benefits, nor was any interest expense or penalties recognized during the year ended December 31, 2010.

The Company was in a net taxable loss position in 2010. The income tax provision for all years includes minimum state tax and revisions of prior years’ estimated taxes. The federal tax benefit in 2009 is related to a net operating loss (“NOL”) carryback refund claim for alternative minimum taxes (“AMT”) paid in a prior year.

Total income tax expense (benefit) of $5,000 and $(170,000) for the years ended December 31, 2010 and 2009, respectively, was allocated to income from continuing operations and is classified as a current provision.

 

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The primary components of the net deferred tax asset (“DTA”) are as follows at December 31, 2010 and 2009 (in thousands):

 

     December 31,  
     2010     2009  

Deferred tax asset:

    

Net operating loss carryforwards

   $ 66,595      $ 65,103   

Depreciation and amortization

     3,119        4,101   

Accruals and reserves

     538        502   

Tax credits

     535        535   

Share-based compensation

     3,771        3,334   
                

Total deferred tax assets

     74,558        73,575   

Less: valuation allowance

     (74,558     (73,575
                

Total

   $ —        $ —     
                

As of December 31, 2010, the Company has NOL carryforwards, after considering Internal Revenue Code Section 382 limitations, of approximately $178.9 million and $98.7 million for federal and state purposes, respectively. The Company also has AMT credit carryforwards of $0.1 million for both federal and state purposes. The NOL carryforwards will expire at various dates beginning in 2012 through 2030 if not utilized. The AMT tax credit carryforwards may be carried forward indefinitely. Included in the NOL carryforwards are tax benefits resulting from the exercise of stock options totaling $46.8 million and $24.5 million for federal and state purposes, respectively.

A valuation allowance existed as of December 31, 2010 and 2009, due to the uncertainty of deferred tax asset utilization based on the Company’s history of losses. The valuation allowance increased by $1.0 million and 2.0 million for the years ended December 31, 2010 and 2009, respectively.

The difference between the Company’s effective income tax rate and the federal statutory rate for the years ended December 31, 2010 and 2009 is reconciled below:

 

     December 31,  
     2010     2009  

Federal tax rate from continuing operations

     34.0     34.0

State taxes, including permanent differences

     0.5     -0.1

Change in valuation allowance

     -35.2     -26.1

Change in state tax rate

     0.0     -4.9

Other

     1.0     -0.2
                

Total

     0.3     2.7
                

 

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10. Commitments and Contingencies

As of December 31, 2010, future minimum payments under all capital and operating leases are as follows (in thousands):

 

     CNB
Capital Lease
    Operating
Leases
     Total  

Years ending December 31,

       

2011

     1,120        592         1,712   

2012

     617        517         1,134   

2013

     145        536         681   

2014

     —          557         557   
                         

Total minimum payments

     1,882      $ 2,202       $ 4,084   
                   

Less: amount representing interest

     (98     
             

Present value of net minimum payments

     1,784        

Less: current portion

     (1,048     
             

Long-term portion of capital lease obligations

   $ 736        
             

Operating Leases

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 scheduled base rent payments, the Company will also be responsible for varying amounts of operating and property tax expenses.

The Company’s previous headquarters were located in approximately 135,000 square feet of leased office space in San Francisco, California. The lease term for this office space expired on November 30, 2009. The Company also had five primary subtenants at its previous headquarters facility in San Francisco. The Company had subleased approximately 57,750 square feet of space through October 2009 and 34,595 square feet of space through November 2009.

Rent expense under all operating leases for the years ended December 31, 2010 and 2009 was $0.6 million and $1.3 million (net of sublease income of $2.5 million for the year ended December 31, 2009), respectively. Rent expense for the year ended December 31, 2009 is net of lease restructuring adjustments related to certain leased facilities (see Note 7).

Letters of Credit

At December 31, 2010, the Company has an outstanding SBLC related to the security of a building lease for $0.3 million. At December 31, 2009, the Company had outstanding SBLCs related to the security of a building lease for $0.3 million and security on an equipment lease for $0.2 million. In March 2010, the equipment lease requiring the $0.2 million SBLC was cancelled and the SBLC was released by the vendor and terminated in May 2010. The remaining SBLC contains two financial covenants, with which the Company was in compliance as of December 31, 2010.

The agreements with CNB, consisting of the SBLCs and master equipment lease agreement, contain cross-default provisions, whereby a default under one is deemed a default for the other, and are secured by a general

 

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lien on all assets of the Company. As of December 31, 2010 and 2009, the Company was not in default on either agreement with CNB (see Note 8).

Purchase Obligations

At December 31, 2010, the Company had outstanding purchase obligations of $1.1 million relating to an open purchase order for which the Company had not received the related services or goods and a non-cancelable contractual obligation relating to IT data center operations.

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 various lessors in connection with facility leases for certain claims arising from such facility or lease.

Customer Indemnification

On September 4, 2008, the Company agreed to indemnify one of its Publisher Solutions customers, IAC, pursuant to an indemnification agreement contained in an AdCenter for Publishers’ contract. The obligation arose from a Complaint, which was filed on October 16, 2007 in the United States District Court for the Eastern Division of Texas against IAC and others, alleging that the Company’s AdCenter for Publisher violates the plaintiff’s patent and seeks injunctive relief and unspecified damages. See Performance Pricing v. Google, Inc. et. al., Civil Action No. 2:07 cv 00432-LED, United States District Court for the Eastern District of Texas (the “Action”). On or about February 18, 2009, the Company entered into a Settlement Agreement with the plaintiffs, whereby the Company agreed to pay the plaintiffs $0.6 million in exchange for a dismissal of the Action against IAC, release of IAC and the Company for any past damages for infringement and a future license for the Company and its customers. On or about February 12, 2009, the Company also agreed to pay IAC’s defense costs in the Action which totaled $0.4 million. On or about March 4, 2009, the Court dismissed the Action against IAC. During the six months ended June 30, 2009, the Company paid the $0.6 million required by the Settlement Agreement, the $0.4 million IAC defense cost reimbursement and $0.1 million of legal expenses associated with the Action.

Officer and Director Indemnification

Further, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was, serving, at the Company’s request, in such capacity, to the maximum extent permitted under the laws of the State of Delaware. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. However, the Company maintains directors and officers insurance coverage that may contribute, up to certain limits, a portion of any future amounts paid, for indemnification of directors and officers. The Company believes the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal. Historically, the Company has not incurred any losses or recorded any liabilities related to performance under these types of indemnities.

 

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Legal Proceedings

The Company is involved, from time to time, in various legal proceedings arising from the normal course of business activities. Although the results of litigation and claims cannot be predicted with certainty, the Company does not expect resolution of these matters to have a material adverse impact on its consolidated results of operations, cash flows or financial position unless stated otherwise. However, an unfavorable resolution of a matter could, depending on its amount and timing, materially affect its results of operations, cash flows or financial position in a future period. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense costs, diversion of management resources and other factors.

Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc.

On March 14, 2005, the Company was served with the second amended complaint in a class action lawsuit in the Circuit Court of Miller County, Arkansas. The complaint named eleven search engines and web publishers as defendants, including the Company, and alleged breach of contract, restitution/unjust enrichment/money had and received, and civil conspiracy claims in connection with contracts allegedly entered into with plaintiffs for Internet pay-per-click advertising. The named plaintiffs on the second amended complaint were Lane’s Gifts and Collectibles, L.L.C., U.S. Citizens for Fair Credit Card Terms, Inc., Savings 4 Merchants, Inc., and Max Caulfield d/b/a Caulfield Investigations.

On July 26, 2006, the Court approved a class settlement among plaintiffs, defendant Google, Inc., and certain defendants who display Google advertisements on their networks (the “Google Settlement”). The Google Settlement purports to release Google of all claims and also purports to release certain defendants, including the Company, for any claims associated with the display of Google advertisements on their networks. On February 29, 2008, the court approved a Stipulation and Settlement Agreement (the “Settlement Agreement”) to settle the matter in its entirety. Pursuant to the Settlement Agreement, the Company established a Settlement Fund in the amount of approximately $2.5 million allocated as follows: (a) a Class Member Fund of approximately $2.0 million in advertising credits, (b) the Fees Award to Class Counsel of approximately $0.6 million, and (c) an Incentive Award to the three Class Representatives of an immaterial amount that was paid. On April 7, 2008, the Company paid approximately $0.6 million of legal fees to the plaintiff’s counsel representing the Fees Award to Class Counsel. On April 29, 2008, the Company began to issue advertising credits to the Class Members who filed timely claims. The deadline for submitting claims for advertising credits expired on April 29, 2009. The Company recorded an estimate in accrued liabilities of the amount of the loss on settlement which management determined was probable and estimable during the year ended December 31, 2007. During 2007, the Company recovered settlement proceeds from its insurance carrier which exceeded the recorded estimate of the amount of loss on settlement. Due to the uncertainty relating to the ultimate settlement amount, the excess settlement proceeds remain as an accrued liability at December 31, 2010 and 2009.

As of December 31, 2010 and 2009, the legal proceedings liability of $0.3 million is classified in accrued liabilities on the Company’s Consolidated Balance Sheets.

 

11. Stockholders’ Equity

In August 2010, in accordance with a shareholder approval at the Annual Meeting in July 2010, the Company amended its Certificate of Incorporation to reduce the authorized shares of common stock from 200 million shares to 80 million shares.

 

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Share-Based Compensation

Stock Option Plans

In December 1997, the Company approved the 1998 Stock Option Plan (the “Plan”). In October 2000, the Company acquired Zeal Media, Inc. and assumed all the stock options outstanding under the 1999 Zeal Media, Inc. Stock Plan (the “Zeal Plan”). In April 2002, the Company acquired Wisenut, Inc. and assumed all the stock options outstanding under the Wisenut, Inc. 1999 Stock Incentive Plan (the “Wisenut Plan”). On June 19, 2007, the stockholders approved the LookSmart 2007 Equity Incentive Plan (the “2007 Plan”). Under the 2007 Plan, the Company may grant incentive stock options, nonqualified stock options, stock appreciation rights and stock rights to employees, directors and consultants. Share-based incentive awards are provided under the terms of these four plans (collectively, the “Plans”).

The Company’s Plans are administered by the Compensation Committee of the Board of Directors. Awards under the Plans principally include at-the-money options and fully vested restricted stock. Except for the one time share grants to certain executive officers that become exercisable over a two year period, outstanding stock options generally become exercisable over a three or four year period from the grant date and have a term of ten years. Beginning in 2008, the Company issued fully vested restricted stock to certain directors and executive officers. The number of shares reserved for issuance under the Plans was approximately 4.5 million and 4.8 million shares of common stock at December 31, 2010 and 2009, respectively. There were 1.6 million shares available to be granted under the Plans at December 31, 2010.

Share-based compensation expense recorded during the years ended December 31, 2010 and 2009 was included in the Company’s Consolidated Statement of Operations as follows (in thousands):

 

     Year Ended
December 31,
 
     2010      2009  

Sales and marketing

   $ 69       $ 141   

Product development and technical operations

     322         533   

General and administrative

     288         943   
                 

Total share-based compensation expense

     679         1,617   

Amounts capitalized as software development costs

     41         74   
                 

Total share-based compensation

   $ 720       $ 1,691   
                 

Total unrecognized share-based compensation expense related to share-based compensation arrangements at December 31, 2010 was $0.8 million and is expected to be recognized over a weighted-average period of approximately 2.5 years. The total fair value of equity awards vested during the years ended December 31, 2010 and 2009 was $0.7 million and $1.7 million, respectively.

 

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Option Awards

Stock option activity under the Plans during the years ended December 31, 2010 and 2009 is as follows:

 

     Shares     Weighted-
Average
Exercise Price
Per Share
     Weighted-
Average
Remaining
Contractual
Term
     Aggregate
Intrinsic
Value
 
     (in thousands)            (in years)      (in thousands)  

Options outstanding at December 31, 2008

     3,818      $ 4.05         

Granted

     328        1.22         

Expired/forfeited

     (937     3.55         
                

Options outstanding at December 31, 2009

     3,209        3.90         

Granted

     998        1.48         

Exercised

     (1     0.91         

Expired/forfeited

     (1,284     3.63         
                

Options outstanding at December 31, 2010

     2,922      $ 3.20         6.28       $ 745   
                                  

Vested and expected to vest at December 31, 2010

     2,610      $ 3.37         6.23       $ 496   
                                  

Exercisable at December 31, 2010

     1,971      $ 3.88         6.08       $ 248   
                                  

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 December 31, 2010:

 

     Options Outstanding      Options Exercisable  

Price Ranges

   Shares      Weighted-
Average
Remaining
Contractual Term
     Weighted-
Average
Exercise Price
Per Share
     Shares      Weighted-
Average
Exercise Price
Per Share
 
     (in thousands)      (in years)             (in thousands)         

$1.02  –  $  2.12

     1,094         6.74       $ 1.44         313       $ 1.33   

  2.57  –      3.60

     1,094         6.64         3.10         930         3.10   

  3.70  –      4.33

     282         6.15         4.08         276         4.08   

  4.45  –    20.55

     452         4.38         7.13         452         7.13   
                          

  1.02  –    20.55

     2,922         6.28         3.20         1,971         3.88   
                          

Stock Awards

During the years ended December 31, 2010 and 2009, the Company issued 35 thousand and 58 thousand shares, respectively, of fully vested restricted stock, with a weighted average grant date fair value of $1.32 and $1.10 per share, respectively, under the Plans. The Company recorded share-based compensation for stock awards of $46 thousand and $63 thousand for the years ended December 31, 2010 and 2009, respectively.

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Employee Stock Purchase Plan

Under the 1999 Employee Stock Purchase Plan (the “1999 ESPP”), which was approved by the shareholders in July 1999, the Company was authorized to issue up to 520 thousand shares of Common Stock to Employees of the Company. Under the 1999 ESPP, substantially all employees could purchase the Company’s common stock through payroll deductions at a price equal to 85 percent of the lower of the fair market value at the beginning of the offering period or at the end of each applicable purchase period. An offering period was 24 months, composed of four six-month purchase periods. ESPP contributions were limited to a maximum of 15 percent of an employee’s eligible compensation, and ESPP participants were limited to purchasing a maximum of 500 shares per purchase period. ESPP share-based compensation expense under the 1999 ESPP was not significant for the year ended December 31, 2009. As of June 8, 2009, when the 1999 ESPP expired, 490 thousand shares had been issued under the 1999 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 2009 ESPP was not significant for the year ended December 31, 2010. As of December 31, 2010, 41 thousand shares have been issued under the 2009 ESPP.

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:

 

     Year Ended December 31,  
           2010                 2009        

Volatility

     64.68     67.39

Risk-free interest rate

     1.57     2.25

Expected term (years)

     4.22        4.90   

Expected dividend yield

     —          —     

Weighted average grant date fair value

   $ 0.75      $ 0.69   

As share-based compensation expense recognized in the 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

One option was exercised in the year ended December 31, 2010. The aggregate intrinsic value of options exercised and the total cash received as a result of exercises under all share-based compensation arrangements was insignificant for the year ended December 31, 2010. No options were exercised in the year ended December 31, 2009. The Company issues new shares of common stock upon exercise of stock options. No income tax benefits have been realized from exercised stock options.

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

12. Fair Value Measurements

Fair Value of Financial Assets

The Company’s financial assets measured at fair value on a recurring basis subject to disclosure requirements at December 31, 2010 and 2009 were as follows (in thousands):

 

     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   
                          
     Balance at
December 31,
2009
     Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
 

Cash equivalents:

        

Money market mutual funds

   $ 10,074       $ 10,074       $ —     

Certificates of deposit

     2,000         —           2,000   

Commercial paper

     6,399         —           6,399   
                          
     18,473         10,074         8,399   
                          

Short-term investments:

        

Corporate bonds

     2,890         —           2,890   

Certificates of deposit

     490         —           490   

Commercial paper

     1,400         —           1,400   
                          
     4,780         —           4,780   
                          

Total financial assets measured at fair value

   $ 23,253       $ 10,074       $ 13,179   
                          

The Company had an insignificant level 3 investment at December 31, 2009. In February 2010, the level 3 investment, a warrant, expired unexercised.

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

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 December 31, 2010 and 2009, the Company did not adjust prices received from the pricing service.

Trade accounts receivable, net: The carrying value reported in the Consolidated Balance Sheets is net of allowances for doubtful accounts and returns which estimate customer non-performance risk.

Trade accounts payable and accrued liabilities: The carrying value reported in the Consolidated Balance Sheets for these items approximates their fair value, which is the likely amount which the liability with short settlement periods would be transferred to a market participant with a similar credit standing as the Company.

 

13. Net Income (Loss) per Share

A reconciliation of the numerator and denominator of basic and diluted net income (loss) per share (“EPS”) is provided as follows (in thousands, except per share amounts):

 

     Year Ended December 31,  
           2010                  2009        

Numerator

     

Income (loss) from continuing operations

   $ 617       $ (6,666

Income from discontinued operations

     358         464   
                 

Net income (loss)

   $ 975       $ (6,202
                 

Denominator

     

Weighted average shares used to compute basic EPS

     17,179         17,108   

Effect of dilutive securities:

     

Dilutive common stock equivalents

     57         —     
                 

Weighted average shares used to compute diluted EPS

     17,236         17,108   
                 

Net income per share—Basic

     

Income (loss) from continuing operations

   $ 0.04       $ (0.39

Income from discontinued operations, net of tax

     0.02         0.03   
                 

Net income (loss) per share—Basic

   $ 0.06       $ (0.36
                 

Net income per share—Diluted

     

Income (loss) from continuing operations

   $ 0.04       $ (0.39

Income from discontinued operations, net of tax

     0.02         0.03   
                 

Net income (loss) per share—Diluted

   $ 0.06       $ (0.36
                 

 

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LOOKSMART, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Options to purchase common stock are not included in the diluted loss per share calculations if their effect is antidilutive. The antidilutive securities which include potential common stock relating to stock options for the year ended December 31, 2009 were 4,590 shares.

For the years ended December 31, 2010 and 2009, 2.7 million and 3.6 million shares, respectively, of potential common stock related to outstanding stock options have been excluded from the calculation of diluted net income (loss) per share as their respective exercise prices were more than the average market value for the respective periods.

 

14. Employee Benefit Plan

The Company has a 401(k) retirement plan covering all eligible employees. Employees may contribute amounts ranging from 1% to 50% of annual salary, up to the maximum limits established by the Internal Revenue Service. The Company matches these contributions in cash up to 5% of annual salary up to a total match of $3 thousand per year. Employees vest 100% immediately in their own contributions and 50% per year in Company matching contributions. Any employer contributions that are not vested are forfeited if an employee leaves the Company, but are reinstated if the employee returns to service within five years. The Company made matching contributions of an insignificant amount and $0.2 million for 2010 and 2009, respectively.

 

15. Related Party Transactions

During the year ended December 31, 2010, Dr. Jean-Yves Dexmier was paid fees totaling $0.4 million and $0.1 million in connection with his services as the Company’s Chief Executive Officer and Executive Chairman of the Board, respectively. During the year ended December 31, 2009, Dr. Dexmier was paid fees totaling $0.1 million and $0.3 million in connection with his services as a member of the Company’s Board of Directors and as a special projects consultant to the Board of Directors, respectively.

 

16. Subsequent Events

On January 7, 2011, the Board of Directors of the Company approved a plan of termination that resulted in a reduction in its workforce of approximately 20 full-time positions, or approximately 35%. The Company will record $0.9 million in pre-tax restructuring charges in the first quarter of 2011. The cash payments associated with the restructuring liability are expected to be paid through the third quarter of 2011.

 

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act, as amended) designed to provide reasonable assurance that the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. These include controls and procedures designed to ensure that this information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of December 31, 2010. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2010 at the reasonable assurance level.

Management’s Annual Report on Internal Control over Financial Reporting.

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). The Company’s internal control over financial reporting is a process, under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives.

Management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on this evaluation, management, with the participation of the Chief Executive Officer and Chief Financial Officer, concluded that, as of December 31, 2010, the Company’s internal control over financial reporting was effective.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to the Dodd-Frank Wall Street Reform and Consumer Act (the “Act”), which permits the company to provide only management’s report in this annual report.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) during the quarter ended December 31, 2010, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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ITEM 9B. OTHER INFORMATION

None.

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this item is incorporated herein by reference to the Company’s definitive proxy statement relating to the 2011 annual meeting of stockholders (the “2011 Proxy Statement”), which the Company intends to file with the Securities and Exchange Commission within 120 days of the end of the Company’s fiscal year ended December 31, 2010.

 

ITEM 11. EXECUTIVE COMPENSATION

The information required under this item may be found in the 2011 Proxy Statement and is incorporated herein by reference.

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required under this item may be found in the 2011 Proxy Statement and is incorporated herein by reference.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

The information required under this item may be found in the 2011 Proxy Statement and is incorporated herein by reference.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required under this item may be found in the 2011 Proxy Statement and is incorporated herein by reference.

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) Financial Statements. The following are filed as part of Item 8 of this Annual Report on Form 10-K:

Report of the Independent Registered Public Accounting Firm

     38   

Consolidated Balance Sheets

     39   

Consolidated Statements of Operations

     40   

Consolidated Statements of Stockholders’ Equity

     41   

Consolidated Statements of Cash Flows

     42   

Notes to the Consolidated Financial Statements

     43   

 

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LOOKSMART, LTD.

SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS

(In thousands)

 

Description

   Balance at
Beginning
of Period
     Charged to
Costs and
Expenses
    Deductions      Balance at
End of
Period
 

Year ended December 31, 2010

          

Allowance for doubtful accounts

   $ 127       $ 48      $ 1       $ 174   

Allowance for returns

     50         263        110         203   

Deferred tax valuaton allowance

     73,575         983        —           74,558   

Year ended December 31, 2009

          

Allowance for doubtful accounts

   $ 277       $ (61   $ 89       $ 127   

Allowance for returns

     250         32        232         50   

Deferred tax valuaton allowance

     71,557         2,018        —           73,575   

Exhibits. The exhibits listed on the Exhibit Index (following the Signatures section of this report) are included, or incorporated by reference, in this Annual Report.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in San Francisco, California, on February 25, 2011:

 

LOOKSMART, LTD.
By:   /s/    WILLIAM O’KELLY        
 

William O’Kelly

Senior Vice President Operations

and Chief Financial Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jean-Yves Dexmier, William O’Kelly and R. Brian Gibson jointly and severally, as his or her attorneys-in-fact, each with the full power of substitution, for him or her, in any and all capacities, to sign any amendment to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting to said attorneys-in-fact, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact or any of them, or their or his or her substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:

 

Signature

  

Title

 

Date

/S/    JEAN-YVES DEXMIER        

Jean-Yves Dexmier

   Executive Chairman of the Board, Chief Executive Officer (Principal Executive Officer)   February 25, 2011

/S/    WILLIAM O’KELLY        

William O’Kelly

   Senior Vice President Operations and Chief Financial Officer (Principal Financial Officer)   February 25, 2011

/S/    R. BRIAN GIBSON        

R. Brian Gibson

   Vice President of Finance (Principal Accounting Officer)   February 25, 2011

/S/    ANTHONY CASTAGNA        

Anthony Castagna

   Director   February 25, 2011

/S/    TERESA DIAL        

Teresa Dial

   Director   February 25, 2011

/S/    MARK SANDERS        

Mark Sanders

   Director   February 25, 2011

/S/    TIMOTHY J. WRIGHT        

Timothy J. Wright

   Director   February 25, 2011

 

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EXHIBIT INDEX

Exhibits

 

Number

  

Description of Document

3.1    Restated Certificate of Incorporation (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on November 9, 2010).
3.2    Bylaws (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on August 14, 2000) (File No. 000-26357).
4.1    Form of Specimen Stock Certificate (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on November 14, 2005).
4.2++    Forms of Stock Option Agreement used by the Registrant in connection with grants of stock options to employees, directors and other service providers in connection with the Amended and Restated 1998 Stock Plan (Filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on October 22, 2004).
4.3++    Form of cover sheet for use with Stock Option Agreement for grants of stock options to executives in connection with the Company’s Executive Team Incentive Plan, Plan Year 2006 (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on May 10, 2006).
4.4++    Form of cover sheet for use with stock option agreement for grants of stock options to executives in connection with the Company’s Executive Team Incentive Plan, Plan Year 2007 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on March 2, 2007).
10.1++    Form of Indemnification Agreement entered into between the Registrant and each of its directors and officers (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on September 14, 1999).
10.2++    Amended and Restated 1998 Stock Plan (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on September 14, 1999).
10.3++    1999 Employee Stock Purchase Plan as amended (Filed with the Company’s Registration Statement on Form S-8 (File No. 333-129987) filed with the SEC on November 29, 2005).
10.6++    LookSmart, Ltd. 2008 Executive Team Incentive Plan (Filed with the Company’s Current Report on Form 8-K filed with the SEC on February 19, 2008).
10.7    Zeal Media, Inc. 1999 Stock Plan (Filed with the Company’s Registration Statement on Form S-8 (File No. 333-51408) filed with the SEC on December 7, 2000).
10.8    Wisenut, Inc. 1999 Stock Incentive Plan (Filed with the Company’s Registration Statement on Form S-8 (File No. 333-86436) filed with the SEC on April 18, 2002).
10.9++    LookSmart 2007 Equity Incentive Plan (Filed with the Company’s Registration Statement on Form S-8 (File No. 333-144384) filed with the SEC on July 6, 2007).
10.12    Lease Agreement with Rosenberg SOMA Investments III, LLC for property located at 625 Second Street, San Francisco, California, dated May 5, 1999 (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on September 14, 1999).
10.18++    LookSmart, Ltd. Form Amended and Restated Change of Control/Severance Agreement (Filed with the Company’s Annual Report on Form 10-K filed with the SEC on March 16, 2009).
10.32    Sponsored Links Master Terms and Conditions between the Registrant and eBay, Inc. dated March 12, 2007 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).

 

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Number

  

Description of Document

10.41++    Promotion letter between the Company and its Vice-President, Technology dated September 7, 2007 (Filed with the Company’s Current Report on Form 8-K with the SEC on September 12, 2007).
10.45++    Promotion letter between the Registrant and its Vice President, Finance and Principal Accounting Officer dated July 10, 2007. (Filed with the Company’s Current Report on Form 8-K filed with the SEC on July 16, 2007).
10.47    Paid Listings License Agreement between the Registrant and Kontera Technologies, Inc. dated July 17, 2006. (Filed with the Company’s Quarterly Report on Form 10-Q with the SEC on August 6, 2010).
10.48+    License Agreement between the Registrant and Oversee.net dated April 1, 2004 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on November 9, 2007).
10.49    Letter from Oversee.net to the Registrant dated January 21, 2008 terminating Agreement between Registrant and Oversee.net dated April 1, 2004 effective September 30, 2008 (Filed with the Company’s Annual Report on Form 10-K filed with the SEC on March 17, 2008).
10.50+    Backfill Agreement between the Registrant and Internext Media Corp. dated February 8, 2008 (Filed with the Company’s Quarterly Report on Form 10-Q on May 12, 2008).
10.51    Paid Listings License Agreement between the Registrant and PeakClick GMBH dated April 15, 2006 (Filed with the Company’s Quarterly Report on Form 10-Q May 7, 2010).
10.52    Advertiser Terms and Conditions between the Registrant and MeziMedia dated September 26, 2008 (Filed with the Company’s Quarterly Report on Form 10-Q on May 7, 2010).
10.53    Paid Listings License Agreement between the Registrant and Wellbourne Limited dated March 15, 2006 (Filed with the Company’s Quarterly Report on Form 10-Q on May 7, 2010).
10.55++    July 13, 2009 Amendment to the Registrant’s Chief Financial Officer’s Offer Letter (Filed with the Company’s Current Report on Form 8-K filed with the SEC on July 13, 2009).
10.56++    Severance Agreement and General Release between the Registrant and its former Senior Vice President, Corporate Development (Filed with the Company’s Current Report on Form 8-K filed with the SEC on June 10, 2009).
10.60++    Employment offer letter between the Registrant and its former Chief Financial Officer dated August 1, 2008 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on August 5, 2008).
10.61++    Board Services Agreement between the Registrant and its Director dated July 1, 2008 (filed with the Company’s Amended Annual Report on Form 10-K/A on April 30, 2009).
10.62++    Amendment to offer letter between Registrant and its former Chief Financial Officer dated March 23, 2009 (filed with the Company’s Quarterly Report on Form 10-Q on May 5, 2009).
10.63    Sublease Agreement with KPMG, LLP for property located at 55 Second Street, San Francisco, California (filed with the Company’s Quarterly Report on Form 10-Q on November 4, 2009).
10.64++    Amendment to offer letter between the Registrant and its former Chief Financial Officer dated July 13, 2009 (filed with the Company’s Current Report on Form 8-K filed with the SEC on July 13, 2008).
10.65    Master Lease Agreement between the Registrant and City National Bank dated April 6, 2007 (Filed with the Company’s Annual Report on Form 10-K filed with the SEC on March 26, 2010).
10.66    Covenants Rider to the Master Lease Agreement between the Registrant and City National Bank dated September 30, 2009 (filed with the Company’s Quarterly Report on Form 10-Q on November 4, 2009).

 

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Number

  

Description of Document

10.67    Irrevocable Standby Letter of Credit Application and Letter of Credit Agreement between the Registrant and City National Bank dated August 14, 2009 (filed with the Company’s Quarterly Report on Form 10-Q on November 4, 2009).
10.68    First Amendment to Supplemental Terms and Conditions Letter between the Registrant and City National Bank dated October 16, 2009 (filed with the Company’s Quarterly Report on Form 10-Q on November 4, 2009).
10.69‡    Master Services Agreement #12223.0.1 between the Registrant and RagingWire Enterprise Solutions, Inc. effective as of October 30, 2009 (Filed with the Company’s Annual Report on Form 10-K filed with the SEC on March 26, 2010).
10.70++    Severance Agreement and General Release dated October 15, 2009 (filed with the Company’s Current Report on Form 8-K filed with the SEC on October 19, 2009).
10.71++    Separation Agreement between LookSmart, Ltd. and Edward F. West dated December 14, 2009 (filed with the Company’s Current Report on Form 8-K filed with the SEC on December 14, 2009).
10.74++    Employment offer letter between the Registrant and its Vice President of Advertising Network Sales dated January 30, 2009 (together with summary of amendment thereto in connection with a salary decrease in June, 2009) (Filed with the Company’s Annual Report on Form 10-K filed with the SEC on March 26, 2010).
10.75++    2009 Employee Stock Purchase Plan (Filed with the Company’s Registration Statement on Form S-8 (File No. 333-165791) filed with the SEC on March 30, 2010).
10.76    Separation Agreement between the Registrant and Michael Schoen dated February 17, 2010 (Filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on February 19, 2010)
10.77‡    Sales Representation Agreement between Registrant and JW Digital, dated October 18, 2009 (filed with the Company’s Quarterly Report on Form 10-Q on May 7, 2010).
10.78    Paid Listings Agreement between the Registrant and Parked.com dated March 13, 2008 (filed with the Company’s Quarterly Report on Form 10-Q on August 6, 2010).
10.79+    Seventh Addendum to the May 2005 AdCenter License, Hosting and Support Agreement between the Registrant and IAC Search and Media effective as of October (filled with the Company’s Quarterly Report on Form 10-Q on November 9, 2010).
10.80++    Consulting Agreement dated as of November 8, 2010 between the Registrant and Dexline (filed with the Company’s Quarterly Report on Form 10-Q on November 9, 2010).
10.81++    Stock Option Agreement effective August 6, 2010 between Registrant and Jean-Yves Dexmier (filed with the Company’s Quarterly Report on Form 10-Q on November 9, 2010).
21.1*    List of Subsidiaries
23.1*    Consent of Independent Registered Public Accounting Firm
24.1*    Power of Attorney (Please see the signature page of this Report)
31.1*    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*    Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(*) Filed herewith

 

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(‡) Material in the exhibit marked with a “***” has been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission. Omitted portions have been filed separately with the Securities and Exchange Commission.
(+) Confidential treatment has been granted with respect to portions of the exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.
(++) Management contract or compensatory plan or arrangement.

 

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