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LOOK > SEC Filings for LOOK > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for LOOKSMART LTD

Form 10-Q for LOOKSMART LTD


14-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The following discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and the Notes to those statements which appear elsewhere in this Quarterly Report on Form 10-Q. The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as "believes," "intends," "expects," "anticipates," "plans," "may," "will" and similar expressions to identify forward-looking statements. Discussions containing forward-looking statements may be found in the material set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and in other sections of this report. All forward-looking statements, including, but not limited to, projections, expectations or estimates concerning our business, including demand for our products and services, mix of revenue sources, ability to control and/or reduce operating expenses, anticipated gross margins and operating results, cost savings, product development efforts, general outlook of our business and industry, future profits or losses, competitive position, share-based compensation, additional expenses to be incurred in connection with the unsolicited tender offer by PEEK, adequate liquidity to fund our operations and meet our other cash requirements, are inherently uncertain as they are based on our expectations and assumptions concerning future events. These forward-looking statements are subject to numerous known and unknown risks and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including but not limited to, the possibility that we may fail to maintain or grow our listings advertiser base and/or distribution network, that existing and potential distribution partners may opt to work with, or favor the products of, competitors if our competitors offer more favorable products or pricing terms, that we may be unable to grow our online search advertising revenue and/or find alternative sources of revenue, that we may be unable to attain or maintain customer acceptance of our publisher solutions products, that changes in the distribution network composition may lead to decreases in query volumes, that we may be unable to maintain or improve our query volume, match rate, number of paid clicks, average revenue per click, conversion rate or other ad network metrics, that we may be unable to achieve or maintain profitability, that we may be unable to retain our existing credit facilities or obtain new credit facilities, that we may be unable to attract and retain key personnel, that we may have unexpected increases in costs and expenses, that we may be unable to remain listed on the NASDAQ Stock Market, or that one or more of the other risks described elsewhere in this report may occur.

All forward-looking statements in this report are made as of the date hereof, based on information available to us as of the date hereof, and except as required by applicable law, we assume no obligation to update any forward-looking statements.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are discussed in our Annual Report on Form 10-K for the year ended December 31, 2011. As of September 30, 2012, there had been no material changes to our critical accounting policies and estimates.

Business Overview

LookSmart, Ltd. ("LookSmart" or the "Company") is a digital advertising solutions company that provides relevant solutions for search and display advertising. LookSmart was organized in 1996 and is incorporated in the State of Delaware.

LookSmart provides advertisers with search marketing and display advertising solutions, and offers publishers the ability to monetize their inventory through our search network:

Search Advertisers: LookSmart search marketing network acquires queries from a large variety of sources and matches them with the keywords of our advertising customers. Our search advertising customers are generally of three types; Intermediaries, Direct Advertisers and Self-Service Advertisers. Intermediaries purchase clicks to sell into the affiliate networks of the large search engine providers. Direct Advertisers and their agencies purchase clicks with the assistance of LookSmart account managers to achieve conversions or sales from the clicks or to obtain unique page views. Self-Service Advertisers are small Direct Advertisers that sign-up online, pay by credit card and manage their account with minimal LookSmart account management assistance. 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.

Display Advertisers: LookSmart also offers advertisers the ability to buy graphical display advertising. LookSmart's trading desk personnel utilizes DSP technology and licensed data from third party providers to buy targeted advertising on a real-time bidded basis. By leveraging our extensive historical search marketing network data along with performance data from a conversion pixel, LookSmart constructs models of the highest performing audiences, and targets them via exchange inventory. LookSmart offers its trading desk as a managed service.

For Publishers: 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.


Table of Contents

In 2011, revenue from Intermediaries decreased significantly. The decrease was primarily driven by a revenue decrease throughout the year, including a significant decrease in the fourth quarter of 2011 due to revenue chargebacks to our Intermediary customers by large search engine providers. This had a severe impact to Intermediary business models and consequently the business they conduct with us. We ceased business with several Intermediaries as a result; however beginning in the second quarter of 2012, our Intermediary business and associated revenue began to increase. Intermediary revenue has increased to the point that it is currently the largest component of our overall revenue. We expect Intermediary revenue will continue to be the largest component of our revenue for the foreseeable future.

Unsolicited Tender Offer

In July 2012, PEEK and other persons acting in concert with PEEK made an unsolicited proposal to acquire the Company and subsequently commenced a tender offer for all outstanding shares of our common stock. As extended, the tender offer is scheduled to expire on November 30, 2012.

As more fully described in the Company's Solicitation/Recommendation on Schedule 14D-9 filed with the SEC on August 2, 2012, as amended, in response to the offer, the Company's Board of Directors unanimously recommended that the Company's stockholders reject the offer and not tender their shares to PEEK for purchase. We are currently engaged in discussion with PEEK with respect to possible board representation rights and related agreements and transactions. However, the Company cannot guarantee that the negotiations will result in any agreement between the Company and PEEK. Responding to PEEK's unsolicited tender offer resulted in the Company incurring significant additional legal and other advisory costs with respect to the tender offer and the Company may incur additional such expenses in the future. In relation to the tender offer, we have recorded $0.6 million in expenses during the three months ended September 30, 2012, consisting primarily of legal, advisory, and other professional services fees.

Results of Operations

Overview of the Three and Nine Months Ended September 30, 2012 and 2011

The following tables set forth selected information concerning our results of
operations for the periods indicated (in thousands):

                                                                          Three Months Ended September 30,
                                                                     % of                      % of         Dollar         %
                                                        2012       Revenue        2011       Revenue        Change      Change
Revenue                                               $  3,915        100.0 %    $ 7,356        100.0 %    $ (3,441 )       (47 %)
Cost of revenue                                          2,564         65.5 %      4,187         56.9 %      (1,623 )       (39 %)
Gross profit                                             1,351         34.5 %      3,169         43.1 %      (1,818 )       (57 %)
Operating expenses:
Sales and marketing                                        682         17.4 %        565          7.7 %         117          21 %
Product development and technical operations             1,437         36.7 %      1,767         24.0 %        (330 )       (19 %)
General and administrative                               1,743         44.5 %      1,066         14.5 %         677          64 %
Restructuring charge                                       159          4.1 %          -          0.0 %         159         100 %
Total operating expenses                                 4,021        102.7 %      3,398         46.2 %         623          18 %
Loss from operations                                    (2,670 )      (68.2 %)      (229 )       (3.1 %)     (2,441 )      1066 %
Non-operating income, net                                   16          0.4 %          9          0.1 %           7          78 %
Loss from continuing operations before income taxes     (2,654 )      (67.8 %)      (220 )       (3.0 %)     (2,434 )      1106 %
Income tax expense                                           -            -           (4 )       (0.1 %)          4         100 %
Net loss                                              $ (2,654 )      (67.8 %)   $  (224 )       (3.1 %)   $ (2,430 )      1085 %



                                                                            Nine Months Ended September 30,
                                                                     % of                       % of         Dollar          %
                                                        2012       Revenue         2011       Revenue        Change       Change
Revenue                                               $ 11,502        100.0 %    $ 22,350        100.0 %    $ (10,848 )       (49 %)
Cost of revenue                                          7,149         62.2 %      12,281         54.9 %       (5,132 )       (42 %)
Gross profit                                             4,353         37.8 %      10,069         45.1 %       (5,716 )       (57 %)
Operating expenses:
Sales and marketing                                      2,141         18.6 %       1,732          7.7 %          409          24 %
Product development and technical operations             4,780           42 %       4,911         22.0 %         (131 )        (3 %)
General and administrative                               4,468         38.8 %       3,528         15.8 %          940          27 %
Restructuring charge                                       159            1 %         889          4.0 %         (730 )       (82 %)
Total operating expenses                                11,548        100.4 %      11,060         49.5 %          488           4 %
Loss from operations                                    (7,195 )      (62.6 %)       (991 )       (4.4 %)      (6,204 )       626 %
Non-operating income, net                                   32          0.3 %         329          1.5 %         (297 )       (90 %)
Loss from continuing operations before income taxes     (7,163 )      (62.3 %)       (662 )       (2.9 %)      (6,501 )       982 %
Income tax expense                                           -            -            (3 )          -              3        (100 %)
Net loss                                              $ (7,163 )      (62.3 %)   $   (665 )       (2.9 %)   $  (6,498 )       977 %


Table of Contents

Revenue

Revenue is derived from two service offerings or "products" of LookSmart Ltd.
(the "Company"): Advertiser Networks and Publisher Solutions. Total revenue and
revenue from Advertiser Networks and Publisher Solutions for the three and nine
months ended September 30, 2012, and 2011, were as follows (in thousands):

                                          Three Months Ended September 30,
                                    % of                      % of         Dollar         %
                       2012        Revenue       2011        Revenue       Change       Change
Advertiser Networks   $ 3,676            94 %   $ 7,043            96 %   $ (3,367 )        (48 %)
Publisher Solutions       239             6 %       313             4 %        (74 )        (24 %)
Total revenue         $ 3,915           100 %   $ 7,356           100 %   $ (3,441 )        (47 %)



                                            Nine Months Ended September 30,
                                     % of                       % of         Dollar          %
                        2012        Revenue        2011        Revenue       Change        Change
Advertiser Networks   $ 10,626            92 %   $ 21,504            96 %   $ (10,878 )        (51 %)
Publisher Solutions        876             8 %        846             4 %          30            4 %
Total revenue         $ 11,502           100 %   $ 22,350           100 %   $ (10,848 )        (49 %)

Advertiser Networks

The decrease in Advertiser Networks revenue for the three months and nine months ended September 30, 2012, as compared to the same periods in 2011 is the result of a reduction in revenues from Intermediaries, Direct Advertisers and Self Service Advertisers. We experienced a large reduction in Intermediary revenue throughout 2011 and a significant decrease in revenue from Intermediaries in the fourth quarter of 2011due to revenue chargebacks to our customers by large search engine providers. This had a severe impact to Intermediary business models and consequently the business they conduct with us. We have ceased business with several Intermediaries as a result; however, beginning in the second quarter of 2012, our Intermediary business and associated revenue began to increase. Intermediary revenue has increased to the point that it is currently the largest component of our overall revenue, although our overall revenue for Advertisers Networks has continued to decrease. We expect Intermediary revenue will continue to be the largest component of our revenue for the foreseeable future.

Publisher Solutions

Publisher Solutions revenues were lower in the three months ended September 30, 2012, compared to the same period in 2011 due to volume reductions by licensees. Publisher Solutions revenues were higher in the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011, due to additions to licensees and higher transaction volumes in the first quarter of 2012 as compared to the first quarter of 2011.

Cost of Revenue and Gross Margin

Cost of revenue, consisting of TAC which are amounts paid to our distribution
network partners, connectivity costs, hosting expenses, commissions paid to
advertising agencies, and credit card fees were as follows for the three and
nine months ended September 30, 2012, and 2011 (in thousands):

                                                      Three Months Ended September 30,
                                             % of                          % of          Dollar           %
                              2012          Revenue         2011          Revenue        Change         Change
Traffic acquisition costs   $   2,196              56 %   $   3,803              52 %   $  (1,607 )          (42 %)
Other costs                       368               9 %         384               5 %         (16 )           (4 %)
Total cost of revenue       $   2,564              65 %   $   4,187              57 %   $  (1,623 )          (39 %)



                                                      Nine Months Ended September 30,
                                             % of                          % of          Dollar           %
                              2012          Revenue         2011          Revenue        Change         Change
Traffic acquisition costs   $   6,066              53 %   $  11,106              50 %   $  (5,040 )          (45 %)
Other costs                     1,083               9 %       1,175               5 %         (92 )           (8 %)
Total cost of revenue       $   7,149              62 %   $  12,281              55 %   $  (5,132 )          (42 %)

TAC as a percent of Advertisers Network revenue increased in the three and nine months ended September 30, 2012, when compared to the three and nine months ended September 30, 2011. This increase is due to higher TAC on Intermediary business in 2012 as compared to 2011.

Our other costs of revenue, which consist of network operating costs and credit card processing fees, decreased due to the decrease in revenue.


Table of Contents

Operating Expenses

Operating expenses for the three and nine months ended September 30, 2012, as compared to the same period in 2011, increased by $0.6 million and $0.5 million, respectively. Operating expense for the three months ended September 30, 2012 included $0.6 million related to the unsolicited tender offer by PEEK and a $0.2 million restructuring charge for the sublease of the San Francisco headquarters. Operating expense for the nine months ended September 30, 2011, included a $0.9 million restructuring charge for a reduction in workforce in that period. Excluding the effect of those tender offer and restructuring charges, operating expenses decreased by $0.1 million in the three months ended September 30, 2012, compared to the three months ended September 30, 2011, and increased by $0.6 million in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. Responding to PEEK's unsolicited tender offer resulted in the Company incurring significant additional legal and other advisory costs with respect to the tender offer and the Company may incur additional such expenses in the future. In relation to the PEEK tender offer, we have recorded $0.6 million in expenses during the three months ended September 30, 2012, consisting primarily of legal, advisory, and other professional services fees. Operating expenses consist of sales and marketing, product development and technical operations, general and administrative, and restructuring charges for the three and nine months ended September 30, 2012, and 2011, and were as follows (in thousands):

                                                  Three Months Ended September 30,
                                         % of                         % of           Dollar           %
                          2012         Revenue         2011          Revenue         Change         Change
Sales and marketing     $     682             17 %   $     565               8 %   $      117             21 %
Product development
and technical
operations                  1,437             37 %       1,767              24 %         (330 )          (19 %)
General and
administrative              1,743             45 %       1,066              14 %          677             64 %
Restructuring charge          159              4 %           -               0 %          159            100 %
Total operating
expenses                $   4,021            103 %   $   3,398              46 %   $      623             18 %



                                                  Nine Months Ended September 30,
                                         % of                         % of           Dollar           %
                          2012         Revenue         2011          Revenue         Change         Change
Sales and marketing     $   2,141             19 %   $   1,732               7 %   $      409             24 %
Product development
and technical
operations                  4,780             41 %       4,911              22 %         (131 )           (3 %)
General and
administrative              4,468             39 %       3,528              16 %          940             27 %
Restructuring charge          159              1 %         889               4 %         (730 )          (82 %)
Total operating
expenses                $  11,548            100 %   $  11,060              49 %   $      488              4 %

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 and allocation of depreciation. Sales and marketing expenses also include the costs of advertising, trade shows, public relations activities and various other activities supporting our customer acquisition effort. The increase in sales and marketing expenses for the three and nine months ended September 30, 2012, is primarily due to higher compensation related expense associated with increased headcount.

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.


Table of Contents

Product development and technical operations and capitalized software development costs for the three and nine months ended September 30, 2012, and 2011, were as follows (in thousands):

                                                                                  Three Months Ended September 30,
                                                                           % of                       % of         Dollar         %
                                                              2012        Revenue        2011        Revenue       Change       Change
Product development and technical operations costs           $ 1,775            45 %    $ 1,853            25 %    $   (78 )         (4 %)
Capitalized software development costs                          (338 )          (8 %)       (86 )          (1 %)      (252 )        293 %
Total product development and technical operations expense   $ 1,437            37 %    $ 1,767            24 %    $  (330 )        (19 %)



                                                                                  Nine Months Ended September 30,
                                                                           % of                       % of         Dollar         %
                                                              2012        Revenue        2011        Revenue       Change      Change
Product development and technical operations costs           $ 5,743            50 %    $ 5,260            24 %    $   483           9 %
Capitalized software development costs                          (963 )          (8 %)      (349 )          (2 %)      (614 )      (176 %)
Total product development and technical operations expense   $ 4,780            42 %    $ 4,911            22 %    $  (131 )        (3 %)

The decrease in product development and technical operations expense, net of capitalized software development costs for the three and nine months ended September 30, 2012, is primarily due to decreased travel costs.

General and Administrative

General and administrative expenses include costs of executive management, human resources, finance, facilities, and desktop support 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, professional services fees and the provision for, and reductions of, the allowance for doubtful trade receivables.

The increase in general and administrative expenses for the three and nine months ended September 30, 2012, is primarily due to costs of $0.6 million related to the unsolicited tender offer by PEEK and a $0.2 million restructuring charge for the sublease of the San Francisco headquarters.

Restructuring Charges

The Company entered into an agreement to sublease its office space in San Francisco under terms generally equivalent to its existing commitment. The Company had $0.2 million in restructuring costs associated with the sub-lease of the San Francisco headquarters in the three and nine months ended September 30, 2012. The Company had $0.9 million in restructuring costs associated with the reduction of its headcount in the nine months ended September 30, 2011.

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