<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
________________
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Quarterly Period Ended September 30, 2000
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 (I.R.S. Employer
incorporation or organization) Identification No.)
625 Second Street
San Francisco, California 94107
(Address of Principal Executive Offices and Zip Code)
(415) 348-7000
(Registrant's Telephone Number, Including Area Code)
Check whether the registrant: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the preceding 12
months (or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [_]
As of October 31, 2000, there were 90,060,723 shares of the registrant's
common stock outstanding.
<PAGE>
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C>
PART I FINANCIAL INFORMATION
ITEM 1: Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of December 31, 1999
and September 30, 2000........................................ 3
Condensed Consolidated Statements of Operations and
Comprehensive Loss for the three and nine months ended
September 30, 1999 and 2000................................... 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 1999 and 2000...................... 5
Notes to Condensed Consolidated Financial Statements.......... 6
ITEM 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 11
Factors Affecting Operating Results........................... 16
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk.... 28
PART II OTHER INFORMATION
ITEM 2: Changes in Securities and Use of Proceeds..................... 29
ITEM 6: Exhibits and Reports on Form 8-K.............................. 29
ITEM 7: Signatures.................................................... 30
</TABLE>
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LOOKSMART, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
<TABLE>
<CAPTION>
December 31, September 30,
1999 2000
------------ -------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................... $ 75,971 $ 53,714
Restricted cash............................. --- 45,300
Short term investments...................... 28,038 13,902
Trade accounts receivable, net.............. 8,039 16,523
Accounts receivable from related parties.... 980 2,189
Other current assets........................ 4,675 11,189
-------- ---------
Total current assets...................... 117,703 142,817
Property and equipment, net................... 11,595 13,545
Goodwill and intangible assets, net........... 29,301 20,452
Investment in joint venture................... --- 2,051
Other assets.................................. 2,920 5,972
-------- ---------
Total assets.................................. $161,519 $ 184,837
======== =========
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable...................... $ 4,002 $ 6,132
Other accrued liabilities................... 12,915 17,373
Deferred revenue............................ 16,705 14,233
Income taxes payable........................ 650 507
Capital lease obligations--current portion.. 743 751
-------- ---------
Total current liabilities.................. 35,015 38,996
Deferred revenue.............................. 4,919 ---
Capital lease obligations..................... 1,423 892
Credit facility--joint venture partner........ --- 50,000
Minority interest............................. 610 317
Note payable.................................. --- 441
Other liabilities............................. --- 6,462
-------- ---------
Total liabilities......................... 41,967 97,108
Stockholders' equity:
Capital stock................................. 86 89
Additional paid-in capital.................... 211,305 217,499
Deferred stock compensation and other......... (3,904) (2,360)
Accumulated deficit........................... (87,935) (127,499)
-------- ---------
Total stockholders' equity................... 119,552 87,729
-------- ---------
Total liabilities and stockholders' equity... $161,519 $ 184,837
======== =========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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LOOKSMART, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In Thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine months Ended
September 30, September 30,
1999 2000 1999 2000
---- ---- ---- ----
(unaudited) (unaudited)(unaudited)(unaudited)
<S> <C> <C> <C> <C>
Revenues:
Advertising syndication $ 6,258 $ 18,951 $ 11,882 $ 48,906
Licensing 4,601 6,371 14,227 16,134
Ecommerce 2,422 4,755 4,242 11,596
Listings --- 3,287 --- 5,529
-------- -------- -------- --------
Total revenues 13,281 33,364 30,351 82,165
Cost of revenues:
Advertising syndication 1,009 1,433 1,757 3,521
Ecommerce 1,339 2,851 2,469 7,016
Listings --- 487 --- 487
-------- -------- -------- --------
Total cost of revenues 2,348 4,771 4,226 11,024
-------- -------- -------- --------
Gross profit 10,933 28,593 26,125 71,141
-------- -------- -------- --------
Operating expenses:
Sales and marketing (exclusive of deferred stock compensation
of 1,322 and 321 in the three months ended September 30, 1999 and 2000,
respectively, and 2,249 and 1,093 in the nine months ended
September 30, 1999 and 2000, respectively) 17,489 23,335 34,646 59,646
Product development (exclusive of deferred stock compensation
of 3,718 and 159 in the three months ended September 30, 1999 and 2000,
respectively, and 4,686 and 535 in the nine months ended
September 30, 1999 and 2000, respectively) 8,655 8,921 18,222 26,976
General and administrative (exclusive of deferred stock
compensation of 790 and 180 in the three months ended
September 30, 1999 and 2000, respectively, and 1,690 and 675 in the
Nine months ended September 30, 1999 and 2000, respectively) 2,098 3,011 5,764 9,143
Amortization of goodwill and intangibles 1,806 1,612 3,724 5,388
Amortization of deferred stock compensation 5,830 660 8,625 2,303
-------- -------- -------- --------
Total operating expenses 35,878 37,539 70,981 103,456
-------- -------- -------- --------
Loss from operations (24,945) (8,946) (44,856) (32,315)
Non-operating income (expenses):
Interest and other non-operating income(expense), net 936 (918) 1,525 (956)
Share of joint venture income (loss) --- (3,105) --- (6,649)
Minority interest --- 95 --- 490
-------- -------- -------- --------
Loss before income taxes (24,009) (12,874) (43,331) (39,430)
Income taxes --- (41) (52) (135)
-------- -------- -------- --------
Net loss (24,009) (12,915) (43,383) (39,565)
-------- -------- -------- --------
Other comprehensive income
Change in foreign currency translation adjustment during the period (1) (108) (30) (208)
Change in unrealized gains/losses during the period --- 78 --- (256)
-------- -------- -------- --------
Comprehensive loss $(24,010) $(12,945) $(43,413) $(40,029)
======== ======== ======== ========
Basic and diluted net loss per share $ (0.45) $ (0.14) $ (1.36) $ (0.45)
======== ======== ======== ========
Weighted average shares outstanding used in per share calculation 53,270 89,575 31,842 88,517
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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LOOKSMART, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
<TABLE>
<CAPTION>
Nine months
Ended September 30,
1999 2000
---- ----
(unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................................. $(43,383) $(39,565)
Adjustments to reconcile net loss to cash used in operating activities:
Share of joint venture loss............................................. --- 6,649
Depreciation and amortization........................................... 5,137 8,861
Warrant non-cash charge................................................. ---- 157
Amortization of deferred stock compensation............................. 8,624 2,303
Changes in operating assets and liabilities:
Trade accounts receivable.............................................. (2,903) (7,983)
Prepaid expenses....................................................... (10,410) (6,029)
Other assets........................................................... (3,180) (3,567)
Trade accounts payable................................................. 2,310 2,130
Other accrued liabilities and payables................................. 3,261 12,727
Deferred revenues...................................................... 13,911 (4,922)
Minority interest...................................................... --- (293)
-------- --------
Net cash used in operating activities................................ (26,744) (29,532)
-------- --------
Cash flows provided (used) by investing activities:
Acquisitions............................................................ (10,331) (811)
Purchase of short-term investments...................................... (20,078) (13,902)
Proceeds from sale of short-term investments............................ --- 28,188
Funding to joint venture................................................ --- (8,700)
Restricted cash......................................................... --- (45,300)
Purchase of property and equipment...................................... (7,429) (5,423)
-------- --------
Net cash provided (used) by investing activities...................... (37,838) (45,948)
Cash flows from financing activities:
Proceeds from note....................................................... --- 472
Repayment on notes....................................................... (1,500) (31)
Repayments on equipment lease............................................ --- (523)
Proceeds from joint venture partner credit facility...................... --- 50,000
Proceeds from issuance of preferred stock, net........................... 60,887 ---
Proceeds from exercise of common stock warrants.......................... 1,321 ---
Proceeds from issuance of common stock................................... 96,705 3,513
-------- --------
Net cash provided by financing activities............................. 157,413 53,431
Effect of exchange rate changes on cash..................................... 25 (208)
-------- --------
Increase (decrease) in cash and cash equivalents............................ 92,856 (22,257)
Cash and cash equivalents, beginning of period.............................. 3,501 75,971
-------- --------
Cash and cash equivalents, end of period.................................... $ 96,357 $ 53,714
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
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LOOKSMART, LTD. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Summary of Significant Accounting Policies
Nature of Business and Principles of Consolidation
LookSmart offers its business partners and consumers comprehensive Internet
search infrastructure services. LookSmart distributes its proprietary directory
to a large number of Internet users through LookSmart owned web properties, as
well as its strategic partners, including portals, Internet service providers
and media companies.
The consolidated financial statements include the accounts of the Company
and its subsidiaries: LookSmart International Pty Ltd, Futurecorp International
Pty Ltd, BeSeen.com, Inc., LookSmart Netherlands B.V. and LookSmart Holdings
(Delaware), Ltd. Investments in 20% to 50% owned partnerships and affiliates are
accounted for on the equity method and investments in less than 20% owned
affiliates are accounted for on the cost method. All significant intercompany
balances and transactions have been eliminated in consolidation.
Revenue Recognition
The Company generates revenues from advertising syndication, licensing,
ecommerce and listings activities. Advertising syndication revenues are derived
from the sale of advertisements on the websites of the Company and its
distribution affiliates in conjunction with returning search content.
Advertising syndication revenues are recognized ratably as impressions are
delivered over the period in which the advertisement is displayed, provided that
no significant Company obligations remain at the end of a period and collection
of the resulting receivable is reasonably assured. Company obligations typically
include guarantees of a minimum number of "impressions," or times that an
advertisement appears in pages viewed by users of the Company's or its partners'
online properties. To the extent minimum guaranteed impressions are not met, the
Company defers recognition of the corresponding revenues until the remaining
guaranteed impression levels are achieved.
Revenues also include barter transactions which are the exchange of
advertising space on the Company's websites for advertising space on other
websites. In accordance with EITF No. 99-17, "Accounting for Advertising Barter
Transactions", these transactions are recorded at the fair value of similar
advertisement for which cash was received. For the three months ended September
30, 1999 and 2000 the Company recognized $24,000 and $205,000, respectively, for
barter transactions. For the nine months ended September 30, 1999 and 2000 the
Company recognized $222,000 and $1.6 million, respectively, for barter
transactions.
Revenues associated with licensing contracts are recognized as delivery
occurs as specified under the contracts, all performance obligations have been
satisfied, and no refund obligations exist. Payments from customers received in
advance of delivery are recorded as deferred revenues.
The Company's ecommerce revenue is generated by the sale of merchandise.
Prior to the sale of our Choicemall property in May 2000 (See Note 5), the
Company also generated ecommerce revenue from the design, construction and
hosting of commercial websites. Revenue from the sale of merchandise is reported
on a gross basis because the Company acts as the principal in the transaction
with associated product cost reported as cost of revenues. Revenue is recognized
at the time goods are shipped. Revenue from the design and construction of
websites is recognized when the website is delivered to the customer, or when
the Company's obligation terminates. Hosting revenues are recognized in the
period in which hosting occurs.
6
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Listings revenues include fees received for the expedited review of URLs
for inclusion in the LookSmart database as well as revenues from the
distribution of "contributing links" (URLs) in the LookSmart directory. Revenues
associated with expedited reviews are recognized upon the completion of the
expedited review provided that collection of any resulting receivable is
reasonably assured. Upon completion of an expedited review, the Company has no
further ongoing obligation to the customer.
Recently Issued Accounting Pronouncements
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB
101). SAB 101 becomes effective for the fourth quarter of the year ending
December 31, 2000. The Company is in the process of determining the impact, if
any, that adoption of SAB 101 will have on the consolidated financial
statements.
In December 1999, the Emerging Issues Task Force issued EITF No. 99-17,
"Accounting for Advertising Barter Transactions" (EITF 99-17). EITF 99-17 is
effective for transactions after January 20, 2000. The Company has adopted EITF
99-17 for all reporting periods after December 31, 1999 and it did not have a
material effect on its consolidated financial statements.
In March 2000, the Emerging Issues Task Force issued EITF No. 00-2,
"Accounting for Web Site Development Costs" (EITF 00-2). EITF 00-2 is effective
for fiscal quarters beginning after June 30, 2000. The Company has adopted EITF
00-2, and it did not have a material effect on its consolidated financial
statements.
In July 2000, the Emerging Issues Task Force issued EITF No. 99-19,
"Reporting Revenue Gross vs. Net". EITF 99-19 is effective for years beginning
after December 15, 1999. The Company has adopted EITF 99-19 for all reporting
periods after December 31, 1999 and it did not have a material impact on its
consolidated financial statements.
Reclassifications
Certain reclassifications have been made to prior periods' consolidated
financial statements to conform to the current presentation.
2. Unaudited Interim Financial Information
The accompanying unaudited condensed consolidated financial statements
reflect all adjustments which are normal and recurring in nature, and in the
opinion of management, are necessary for a fair statement of the results of
operations for the periods shown. The results of operations for such periods are
not necessarily indicative of the results expected for any full fiscal year or
for any future period.
Certain information and note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations. These unaudited interim condensed
consolidated financial statements should be read in conjunction with LookSmart's
audited financial statements and notes thereto for the year ended December 31,
1999 as included in LookSmart's Annual Report to Shareholders on Form 10-K, as
filed with the Securities and Exchange Commission.
3. Restricted Cash
On February 15, 2000, the Company borrowed $50.0 million under a credit
facility made available by British Telecommunications (BT). In accordance with
the BT LookSmart joint venture agreement, drawdowns on the credit facility may
be used only for the purpose of funding the BT LookSmart joint venture. As of
September 30, 2000, cash
7
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drawn down on this credit facility has been classified as restricted cash on the
balance sheet and $4.7 million of the cash drawn down has been used to fund the
joint venture (see Note 8).
4. Net Loss Per Share:
In accordance with the requirements of SFAS No. 128, a reconciliation of
the numerator and denominator of basic and diluted loss per share is provided as
follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1999 2000 1999 2000
---- ---- ---- ----
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Numerator--Basic and diluted:
Net loss...................................... $(24,009) $(12,915) $(43,383) $(39,565)
======== ======== ======== ========
Denominator--Basic and diluted:
Weighted average common shares outstanding.... 53,270 89,575 31,842 88,517
======== ======== ======== ========
Basic and diluted loss per share.............. $ (0.45) $ (0.14) $ (1.36) $ (0.45)
======== ======== ======== ========
Pro forma net loss per share:
Weighted average common shares outstanding.... 82,911 72,485
-------- --------
Basic and diluted loss per share.............. $ (0.29) $ (0.60)
======== ========
</TABLE>
The pro forma net loss per share calculation assumes the conversion of all
outstanding preferred stock into common shares and the exercise of all warrants
which expired upon the Company's initial public offering that were outstanding
as of September 30, 1999.
Basic loss per share is computed using the weighted average number of
common shares outstanding during the period. Diluted loss per share is computed
using the weighted average number of common and common equivalent shares
outstanding during the period, if dilutive. Common equivalent shares consist of
the incremental common shares issuable upon conversion of the convertible
preferred stock and shares issuable upon the exercise of stock options and
warrants. For all periods, common equivalent shares are not included in the
computation of diluted loss per share because they are antidilutive. Common
stock equivalents relating to preferred stock, stock options and warrants to
purchase common and preferred shares are as follows (in thousands):
Nine Months
Ended September 30,
Common stock equivalents 1999 2000
------------------------ ---- ----
(unaudited)
Preferred stock..................... --- ---
Options............................. 11,118 11,901
Warrants............................ 3,512 1,980
------ ------
Total dilutive shares............... 14,630 13,881
====== ======
5. Related Party Transactions
The Company has a distribution agreement with Guthy Renker Corporation
(GRC), one of the Company's stockholders. At September 30, 2000, the Company had
a receivable of $480,000 from GRC arising from transactions under the
distribution agreement.
During the quarter ended September 30, 2000, the Company paid $25,000 to
Macquarie Bank Limited, one of the Company's stockholders, for financial
consulting expenses.
During the quarter ended September 30, 2000, the Company received $375,000
from QSound Labs, Inc. for advertising sales as part of a two year agreement.
This agreement calls for QSound to purchase a total of $3.0
8
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million of advertising. The Company has an equity investment in QSound, as a
result of the sale of certain assets and liabilities related to its Choicemall
property to QSound in May 2000.
During the quarter ended September 30, 2000, the Company received $819,000
from Redband Broadcasting for advertising sales. The Company is a minority owner
in Redband Broadcasting.
The Company receives licensing revenues from the BT LookSmart joint venture
for the licensing of LookSmart database content. Revenues from the BT LookSmart
joint venture amounted to $0 and $625,000 for the nine months ended September
30, 1999 and 2000, respectively. As of September 30, 2000 the Company had a
related party receivable of $1.7 million from the BT LookSmart joint venture.
This receivable represents reimbursable costs incurred by the Company on behalf
of the BT LookSmart joint venture and has been recorded as an account receivable
from a related party on the balance sheet as of September 30, 2000.
6. Segment Information
The Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" in the fiscal year ended December 31, 1998.
SFAS 131 establishes standards for reporting information regarding operating
segments in annual financial statements and requires selected information for
those segments to be presented in interim financial reports issued to
stockholders. SFAS 131 also establishes standards for related disclosures about
products and services, geographic areas and major customers. The Company
operates in four segments: advertising syndication, licensing, ecommerce and
listings. In the Condensed Consolidated Statements of Operations and
Comprehensive Loss, the Company reports revenue and cost of revenues for these
four segments based on the services currently provided by each. With the
exception of accounts receivable and deferred revenue, information available to
the chief operating decision makers of the Company does not include allocations
of assets and liabilities or operating costs to the Company's segments. As of
December 31, 1999 and September 30, 2000, accounts receivable by segments are as
follows (in thousands):
December 31, September 30,
1999 2000
---- ----
(unaudited)
Advertising syndication............. $8,368 $19,804
Licensing........................... 269 21
Ecommerce........................... 992 479
Listings............................ --- 635
------ -------
Total............................... 9,629 20,939
Allowance for doubtful accounts..... (610) (3,937)
------ -------
Accounts receivable, net............ $9,019 $17,002
====== =======
As of September 30, 2000, accounts receivable from related parties includes
a $1.7 million receivable from BT which has not been allocated to any of the
Company's segments.
As of December 31, 1999 and September 30, 2000, deferred revenue by
segment was as follows (in thousands):
December 31, September 30,
1999 2000
---- ----
(unaudited)
Advertising syndication............. $ 239 $ 142
Licensing........................... 18,597 14,047
Ecommerce........................... 2,788 ---
Listings............................ --- 44
------- -------
Total............................... $21,624 $14,233
======= =======
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LOOKSMART LTD. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(unaudited)
7. Stock Option Plan
During the nine months ended September 30, 2000, the Company granted
5,568,930 stock options at the then current fair market value of its underlying
common stock. During such period employees exercised an aggregate of 2,583,607
options, and 2,569,163 options were cancelled. Total outstanding stock options
were 11,900,613 as of September 30, 2000.
8. British Telecommunications Joint Venture
In February 2000, LookSmart entered into a joint venture agreement with
British Telecommunications (BT). LookSmart and BT have equal equity interests in
the joint venture, BT LookSmart, which will provide localized directory services
in Europe and Asia. The Company accounts for its investment in the joint venture
using the equity method of accounting. The Company's share of the joint
venture's net income or loss is reported as non-operating income or expense.
The agreement establishing the joint venture requires that both LookSmart
and BT contribute up to $108.0 million in cash through June 2003. Under the
agreement, BT extended a $50.0 million non-recourse credit facility accruing
interest compounded at 20% per annum. LookSmart drew down $50.0 million from the
credit facility in February 2000. Borrowings under the credit facility,
including accrued interest, are convertible into LookSmart common stock at
$35.00 per share at BT's discretion. The fair market value of LookSmart common
stock on the commitment date was $32.875. The credit facility is due in full by
February 2003, unless converted to LookSmart common stock prior to that time.
LookSmart's total funding to the joint venture as of September 30, 2000 was $8.7
million. If LookSmart does not repay the facility when it becomes due, BT's sole
recourse is to convert its debt to LookSmart common stock or to accept a
pro-rata portion of LookSmart's interest in BT LookSmart.
9. Note Payable
In January 2000, the Company issued an unsecured promissory note in the
principal amount of $472,000 to its landlord. The note bears interest at 9% per
annum and is payable in equal monthly installments over a term of 10 years. As
of September 30, 2000 the balance of this note was $441,000.
10. Investments
In July 2000, the Company subscribed for an additional 70,324 shares in one
of its subsidiaries, Futurecorp International Pty Limited (Futurecorp), for
$307,000 in cash. In August 2000, the Company exercised an option to purchase an
additional 125,446 shares of Futurecorp for $414,000 in cash and $276,000 of the
Company's common stock. The Company owns stock which controls 53% of the
outstanding voting rights of Futurecorp.
11. Subsequent Events
On October 27, 2000, the Company completed its acquisition of Zeal Media,
Inc., a community web directory company located in the Los Angeles, California
area. Under the terms of the merger agreement, LookSmart reserved approximately
1,363,419 shares of LookSmart common stock for exchange of all outstanding
shares of Zeal Media and for issuance upon exercise of all outstanding options
and warrants to purchase Zeal Media stock. Based on LookSmart's closing price of
$6.6875 on October 27, 2000, the acquisition had an aggregate value of
approximately $9.1 million. At the closing, LookSmart also paid off outstanding
debt owed by Zeal Media to bridge investors in the amount of approximately
$660,000. LookSmart will account for the transaction under the purchase method
of accounting.
10
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the condensed
consolidated financial statements included in this Form 10Q and the notes to
those statements. The following discussion contains forward-looking statements
that reflect our plans, estimates and beliefs, including without limitation
forward-looking statements regarding anticipated revenue growth, trends in costs
of revenues and operating expenses, international expansion and introduction of
additional services. Our actual results could differ materially from those
discussed in the forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, those discussed
below and elsewhere in this Quarterly Report on Form 10-Q, particularly in the
section below entitled "Factors Affecting Operating Results".
Overview
LookSmart is a leading global Internet search infrastructure company. We
have built a robust suite of scalable, customizable and high-quality search
products and have distributed these products, in varying forms, to our network
of partners and affiliates. We build our search solutions to provide our
partners' Internet users with a fast, effective and high-quality environment to
find the most relevant results. We craft our search solutions to maximize the
generation of revenue for our partners, and because of the scale of our
distributed search solution network, we believe we are able to drive significant
amounts of traffic to various destinations throughout the Internet. Finally, we
build private-label search solutions for our partners that are highly customized
and deeply integrated to meet each of our partners' specific goals. Because our
search solutions leverage our existing Internet directory, we believe we are
able to deploy our search solutions in a cost-effective and scalable manner.
Results of Operations
Revenues
LookSmart's core asset is its directory of Internet content and the
associated search systems we provide that allow companies to search through it.
Our revenue streams are created from the use of this directory and search system
by LookSmart and by other companies who contract to use the directory. We divide
these revenues into four distinct segments:
Licensing. Some companies simply choose to license LookSmart's directory
for a fee. The licensing fee generally entitles a company to make use of the
data written in LookSmart's directory in a contractually-limited manner, and to
retain the advertising fees that displaying search results may generate.
Licensing revenues were $6.4 million for the third quarter and $16.1 million for
the first nine months of 2000, which represents an increase of 38% and 13%,
respectively, when compared with the corresponding periods in 1999. The increase
is due primarily to the one-time delivery of additional URLs to Microsoft in the
third quarter under an amendment to the Microsoft agreement.
Advertising Syndication. Advertising syndication revenues are derived from
the display of advertising in conjunction with returning search content. This
advertising is distinct and generally differentiated from the content. These
revenues were $19.0 million for the third quarter and $48.9 million for the
first nine months of 2000, respectively, which represent increases of 203% and
312% when compared with the corresponding periods in 1999. The increases were
due primarily to the increasing number of advertisers purchasing space on the
Company's syndication network, increased traffic resulting from increased
branding and new syndication deals, and slightly higher effective yields
resulting from better advertising inventory management and increased targeting
of advertising sales.
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Ecommerce. The source of LookSmart's ecommerce revenues are its
merchandising activities. The Company initiated its ecommerce activities in
April 1999. Ecommerce revenues were $4.8 million for the third quarter and $11.6
million for the first nine months of 2000, which represents increases of 96% and
173%, respectively, compared to the corresponding periods in 1999. The increases
are primarily due to the continued strength of our on-line merchandise sales.
Listings. Listings revenues are derived from affiliate commissions and the
creation and distribution of "contributing links" (URLs) in our directory.
Contributing links are URLs in LookSmart's directory that generate revenue.
Specifically, revenues from contributing links come from "cost-per-click"
arrangements, fees for expedited reviews of URLs and periodic maintenance fees.
Listings revenues were $3.3 million for the third quarter and $5.5 million for
the first nine months of 2000. The Company initiated its listings activities in
January 2000.
International revenues accounted for less than 5% of net revenues during
the third quarter and first nine months of 1999 and 2000. Barter revenues also
represented less than 5% of net revenues during those periods.
Cost of Revenues
Advertising Syndication. Advertising syndication cost of revenues was $1.4
million, or 8%, of advertising syndication revenues for the third quarter and
$3.5 million, or 7%, of advertising syndication revenues for the first nine
months of 2000. In the corresponding periods of 1999, advertising syndication
cost of revenues were $1.0 million, or 16% of advertising syndication revenues,
and $1.8 million, or 15% of advertising syndication revenues, respectively.
During the period from September 30, 1999 to September 30, 2000, we invested in
technology infrastructure and hired advertising operations personnel to improve
the management and sale of our advertising inventory which allows us to monetize
our traffic more effectively. The dollar increase in advertising syndication
cost of revenues was due to the salaries and benefits costs of additional
employees in advertising operations, as well as depreciation on additional
capital expenditures related to management of advertising inventory and
increased line rental expenses due to higher traffic levels.
Ecommerce. Ecommerce cost of revenues was $2.9 million, or 60%, of
ecommerce revenues for the third quarter and $7.0 million, or 61%, of ecommerce
revenues for the first nine months of 2000. In the corresponding periods of
1999, ecommerce cost of revenues were $1.3 million, or 55% of ecommerce
revenues, and $2.5 million, or 58% of ecommerce revenues, respectively.
Ecommerce cost of revenues are attributable primarily to merchandise costs.
Listings. Listings cost of revenues was $487,000, or 15%, of listings
revenues for the third quarter and $487,000, or 9%, of listings revenues for
the first nine months of 2000. Listings cost of revenues consists of revenue
sharing payments to partners for traffic directly associated with the
"contributing link" revenue arrangements where LookSmart serves as the principal
in the arrangement. The Company initiated its listings activities in January
2000.
Operating Expenses
Sales and Marketing. Sales and marketing expense was $23.3 million for the
quarter ended September 30, 2000, or 70% of total revenues, as compared to $17.5
million, or 132% of total revenues, for the quarter ended September 30, 1999.
For the nine months ended September 30, 2000, sales and marketing expense was
$59.6 million, or 73% of total revenues, as compared to $34.6 million, or 114%
of total revenues for the nine months ended September 30, 1999. The dollar
increase in sales and marketing expenses for the nine months ended September 30,
2000 as compared to the same period in 1999 is attributable to a number of
factors. Distribution costs increased approximately $18.4 million, primarily due
to an increase in payments to our ISP, media, and
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portal partners and our entry in late 1999 and 2000 into significant new
syndication agreements. Other factors contributing to the increase in sales and
marketing expenses were increases in bad debt expense, marketing sponsorship
costs, and costs related to the expansion of our sales staff.
Product Development. Product development expense was $8.9 million for the
quarter ended September 30, 2000, or 27% of total revenues, as compared to $8.6
million, or 65% of total revenues, for the quarter ended September 30, 1999. For
the nine months ended September 30, 2000, product development expense was $27.0
million, or 33% of total revenues, as compared to $18.2 million, or 60% of total
revenues.
The dollar increase in product development expenses in the nine months
ended September 30, 2000 as compared to the same period in 1999 is primarily due
to increases of $3.0 million and $2.4 million in engineering and product design
costs, respectively. These cost increases are attributable to the significant
increase in personnel needed to expand and maintain our editorial system and
advertising technologies. These costs do not include any expenditures that are
capitalizeable under EITF-002 as web-site development or internal use software
costs. In addition, we started a website live response group in July of 1999,
resulting in an increase of $1.6 million in product development costs in the
nine months ended September 30, 2000 as compared to the same period in 1999.
General and Administrative. General and administrative expense was $3.0
million for the quarter ended September 30, 2000, or 9% of total revenues, as
compared to $2.1 million, or 16% of total revenues, for the quarter ended
September 30, 1999. For the nine months ended September 30, 2000, general and
administrative expense was $9.1 million, or 11% of total revenues, as compared
to $5.8 million, or 19% of total revenues.
The dollar increase in the nine months ended September 30, 2000 as compared
to the same period in 1999 consists primarily of increases in payroll expense
due to our expanding administrative employee base, as well as an increase in
listing, accounting, legal, and other professional service costs incurred during
the second quarter of this year in connection with our listing of CDI's on the
Australian stock exchange.
Amortization of Goodwill and Intangibles. Amortization of goodwill and
intangibles expense was $1.6 million for the quarter ended September 30, 2000,
or 5% of total revenues, as compared to $1.8 million or 14% of total revenues
for the quarter ended September 30, 1999. For the nine months ended September
30, 2000, amortization of goodwill and intangibles expense was $5.4 million, or
7% of total revenues, as compared to $3.7 million or 12% of total revenues for
the nine months ended September 30, 1999.
Goodwill and intangibles are the result of the purchase of intellectual
property at our inception in 1996, the BeSeen.com acquisition in October 1998,
the Guthy-Renker Internet and ITW NewCorp asset purchase transactions in April
1999 and June 1999, and the Futurecorp stock purchase transaction in December
1999. In May 2000, the Company sold certain assets and liabilities related to
its Choicemall property to QSound Labs, Inc., resulting in a $4.6 million
reduction of goodwill acquired in the April 1999 Guthy-Renker Internet asset
purchase. The dollar increase in the nine months ended September 30, 2000 as
compared to the same period in 1999 was due primarily to the fact that the nine
months ended September 30, 2000 includes nine months of amortization expense of
the goodwill resulting from the Guthy-Renker Internet, ITW NewCorp and
Futurecorp purchase transactions.
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Amortization of Deferred Stock Compensation. Amortization of deferred stock
compensation expense was $660,000 for the quarter ended September 30, 2000, or
2% of total revenues, as compared to $5.8 million, or 44% of total revenues, for
the quarter ended September 30, 1999. For the nine months ended September 30,
2000, amortization of deferred stock compensation expense was $2.3 million, or
3% of total revenues, as compared to $8.6 million, or 28% of total revenues.
These amounts were recorded in connection with the grant of stock options
to employees and represent the difference between the deemed fair value of the
common stock underlying the options at the dates of grant and the exercise price
of the related options in accordance with FIN 28. The decrease in amortization
expense in the nine months ended September 30, 2000 as compared to the same
period of last year is primarily due to the forfeiture of stock options by
former employees of the Company.
Non-operating Income (Expense). Non-operating income and expense includes
interest income and expense, our share of the BT Looksmart joint venture income
and loss, and the minority interest's share in the income and loss of one of our
subsidiaries. The Company had net non-operating expense of $3.9 million for the
quarter ended September 30, 2000, as compared to net non-operating income of
$936,000 for the quarter ended September 30, 1999. For the nine months ended
September 30, 2000, our net non-operating expense was $7.1 million, as compared
to a net non-operating income of $1.5 million for the same period last year.
The decrease in net non-operating income for the nine months ended 30, 2000
compared to the same period last year is due to a $6.7 million loss we
recognized as our 50% share of the BT LookSmart joint venture loss. BT LookSmart
initiated operations in February 2000. In addition, the $5.5 million in interest
income we recognized in the nine months ended September 30, 2000 was offset by
$6.4 million in interest expense on the $50.0 million we borrowed under our
credit facility from BT in February, 2000.
Income Taxes
Income tax expense was $41,000 for the quarter ended September 30, 2000
compared to zero income tax expense for the quarter ended September 30, 1999.
For the nine months ended September 30, 2000, income tax expense was $135,000,
compared to $52,000 for the same period in 1999. Income tax expense is primarily
associated with our Australian operations.
Liquidity and Capital Resources
LookSmart invests cash pending investment or use predominantly in debt
instruments that are highly liquid, of high-quality investment grade, and have
maturities of less than one year, with the intent to make such funds available
for operating purposes. At September 30, 2000, the Company had cash and cash
equivalents, restricted cash and short-term investments totaling $112.9 million.
Of this amount, $45.3 million constitutes restricted cash under the BT LookSmart
joint venture agreement and is reserved exclusively for the purpose of funding
the BT LookSmart joint venture.
As of September 30, 2000, we had working capital of $103.8 million. Current
assets included $53.7 million in unrestricted cash and cash equivalents, $45.3
million in restricted cash, and $13.9 million in short-term investments. Current
liabilities included $14.2 million in deferred revenues. Deferred revenues
primarily reflect cash receipts in excess of the revenues earned under our
agreement with Microsoft.
Our operations used cash of $29.5 million and $26.7 million for the nine
months ended September 30, 2000 and 1999, respectively. Net cash used in
operations for the nine months ended September 30, 2000 resulted primarily from
the net losses for the period and increases in prepaid expenses related to our
distribution
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agreements, accounts receivable and other assets, and a decrease in deferred
revenues partially offset by increases in trade accounts payable and accrued
liabilities. Operating activities for the nine months ended September 30, 2000
also includes $6.7 million, which represents the Company's share of the joint
venture's losses.
Our investing activities used cash of $45.9 million and $37.8 million for
the nine months ended September 30, 2000 and 1999, respectively. Investing
activity in each of the periods consists of purchases of short-term investments
and fixed assets. In addition, investing activities for the nine months ended
September 30, 2000 also included our investment of $45.3 million of restricted
cash, liquidating $28.2 million in short-term investments, and our proportionate
share of the funding call by the BT Looksmart joint venture. LookSmart and BT
were each required to make payments totaling $8.7 million to meet this funding
call.
Our financing activities provided cash of $53.4 million and $157.4 million
for the nine months ended September 30, 2000 and 1999, respectively. In February
2000, we borrowed $50.0 million under the BT line of credit. In February 1999
through June of 1999, we received cash proceeds of $500,000 and $60.3 million
from the issuance of Series A and Series C convertible preferred stock,
respectively. In August 1999, we received net cash proceeds of approximately
$96.9 million as a result of our initial public offering.
Our capital requirements depend on numerous factors, including our ability
to generate revenues, product development needs, hiring requirements, ability to
form alliances with strategic partners, market acceptance of our services, and
the amount of resources we invest in directory content, site development, sales
and marketing promotions. We have experienced a substantial increase in
expenditures since inception consistent with growth in operations and staffing.
We anticipate that this will continue for the foreseeable future. Additionally,
we plan to expand our sales and marketing programs and continue to evaluate
possible investments in complementary businesses and technologies.
Management believes that our current working capital is sufficient to meet
our operating requirements for at least the next 12 months. The Company expects
that it will need to seek additional financing if investment plans for our
business change. We cannot assure you that such financing will be available on
reasonable terms when and if required. If we raise additional funds through the
issuance of equity or convertible debt securities, our existing stockholders
will experience dilution of their holdings.
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FACTORS AFFECTING OPERATING RESULTS
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 you could lose all or part of your investment.
We have a history of net losses and expect to continue to incur net losses
We have incurred net losses since our inception, including net losses of
approximately $12.9 million and $64.7 million for the years ended December 31,
1998 and 1999 and $39.6 million for the nine months ended September 30, 2000. As
of September 30, 2000, we had an accumulated deficit of approximately $127.5
million. We expect to have net losses and negative cash flow for the foreseeable
future. The size of these net losses will depend, in part, on our ability to
grow our revenues, capitalize on new sources of revenue and contain our
expenses. We expect to spend significant amounts to:
. develop our international business, particularly through our BT LookSmart
joint venture with British Telecommunications;
. maintain and expand our network of distribution partners;
. continue to develop and expand directories of Internet listings, both in the
U.S. and abroad;
. develop new products and enhance the functionality of our search and
directory listings services; and
. acquire complementary technologies and businesses.
Because our operating expenses are likely to increase significantly in the
near term, we will need to generate significant additional revenues to achieve
operating profitability. Even if we do achieve operating profitability, we may
not be able to achieve net profitability or increase our operating profitability
on a quarterly or annual basis.
Our quarterly revenues and operating results may fluctuate, each of which may
negatively affect our stock price
Our quarterly revenues may fluctuate significantly as a result of a variety
of factors that could affect our operating results in any particular quarter.
These factors include:
. the level of user traffic on our and our distribution partners' websites
and our ability to monetize that traffic in any given quarter;
. the demand for our Internet search and navigation services;
. the level of demand for Internet advertising and changes in the advertising
rates we charge;
. the timing of revenue recognition under our listings, licensing and
advertising contracts;
. the level and timing of our entry into new contracts for advertising,
licensing and syndication;
. seasonality of our advertising and ecommerce revenues, as Internet usage is
typically lower in the first and third quarters of the year;
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. technical difficulties and systems downtime or failures, whether caused by
us, third party service providers or hackers;
. changes in our or our partners' pricing policies or termination of contracts;
and
. the timing of our delivery of URLs under our contract with Microsoft. We
recognize quarterly revenues under this contract based on the number of URLs
added to our database during the quarter relative to the total number of URLs
we are required to add to our database during the relevant six-month period.
As a result, to the extent that we satisfy our database update obligations
unevenly, the revenues we recognize under this contract may be skewed on a
quarter-to-quarter basis.
Our expense levels are based in part on expectations of future revenues
and, to a large extent, are fixed. We may be unable to adjust spending quickly
enough to compensate for any unexpected revenue shortfall. Our operating results
may vary as a result of changes in our expenses and costs.
Due to the above factors, we believe that period-to-period comparisons of
our operating results are not necessarily meaningful, and you should not rely on
them as indicators of our future performance. If our operating results in any
future period fall below the expectations of securities analysts and investors,
the market price of our securities would likely decline.
We may need additional capital in the future to support our growth and
additional financing may not be available to us
Although we believe that our working capital will provide adequate
liquidity to fund our operations and meet our other cash requirements for at
least the next 12 months, 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. In
any case, we may seek to raise additional funds through public or private debt
or equity financings in order to:
. fund our operations and capital expenditures;
. take advantage of favorable business opportunities, including geographic
expansion or acquisitions of complementary businesses or technologies;
. develop and upgrade our technology infrastructure;
. reduce outstanding debt;
. develop new product and service offerings;
. take advantage of favorable conditions in capital markets; or
. respond to competitive pressures.
The capital markets, and in particular the public equity market for
Internet companies, have traditionally 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.
Our business prospects depend on the continued growth of Internet advertising
and our ability to generate advertising revenues
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For the quarter ended September 30, 2000, advertising and syndication
revenues accounted for 57% of our total revenues, as compared to 47% of our
total revenues in the quarter ended September 30, 1999. We expect that revenues
from advertising and syndication will continue to represent a significant
portion of our total revenues for the foreseeable future.
We compete with traditional media such as television, radio and print, as
well as online advertisers and high-traffic websites, for a share of
advertisers' total advertising expenditures. We have experienced, and may
continue to experience, downward pressure on advertising prices in the industry
due to the increasing amount of advertising inventory becoming available on the
Internet. As the Internet evolves, advertisers may find Internet advertising to
be a less effective means of promoting their products or services relative to
traditional advertising media and may reduce or eliminate their expenditures on
Internet advertising. Many potential advertisers and advertising agencies have
only limited experience advertising on the Internet and have not devoted a
significant portion of their advertising expenditures to Internet advertising.
Acceptance of the Internet among advertisers will depend, to a large extent, on
the perceived effectiveness of Internet advertising and the continued growth of
commercial usage of the Internet.
Currently, there are a variety of pricing models for selling advertising on
the Internet, including models based on the number of impressions delivered, the
number of clickthroughs by users, the duration over which the advertisement is
displayed or the number of keywords to which the advertisement is linked. It is
difficult to predict which pricing model, if any, will emerge as the industry
standard. This uncertainty makes it difficult to project our future advertising
rates and revenues that we may generate from advertising. In some cases, we
share advertising revenue with our network partners based on the number of users
directed to advertisements or third party web sites. A decrease in targeted
advertising sold, advertising rates or an increase in revenue sharing
obligations could adversely affect our operating results.
In addition, our ability to earn advertising revenues depends on the number
of advertising impressions per search and the number of clickthroughs. We
believe category searches generally result in a greater number of advertising
impressions per search and a higher number of clickthroughs than keyword
searches. Accordingly, if we are unable to implement category-based search
broadly across our network of affiliates, or if users decide to use keyword
searches more frequently than category searches, our advertising revenues could
decline.
In addition, our advertising revenues will depend on our ability to
achieve, measure and demonstrate to advertisers the breadth of the traffic base
using our search service and the value of our targeted advertising. Filter
software programs that limit or prevent advertising from being displayed on a
user's computer are available. It is unclear whether this type of software will
become widely accepted, but if it does, it would negatively affect Internet-
based advertising.
We derive a significant amount of our revenues from Microsoft, and if Microsoft
terminates their contract with us, our business could be harmed.
We derive a significant amount of our revenues under an agreement with
Microsoft Corporation, and either party may terminate the agreement for any
reason on six months' notice. For the quarter ended September 30, 2000, revenues
from Microsoft under this agreement accounted for $5.8 million or 17.4% of our
total revenues. The cash payments we receive for each six-month period under
this agreement are subject to full or partial refund if we fail to provide the
stated number of URLs during that period. After the agreement is terminated,
Microsoft has the right to continue to use the content we delivered during the
term of the agreement. Microsoft also has the right to sublicense these rights
to others, both during and for up to two years after the term of the agreement.
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Our revenues and income potential are unproven and our business model is
continuing to evolve
We were formed in July 1996 and launched our Internet directory in October
1996. Because of our limited operating history, it is extremely difficult to
evaluate our business and prospects. You should evaluate our business in light
of the risks, uncertainties, expenses, delays and difficulties associated with
managing and growing a relatively new business, many of which are beyond our
control. In addition, we compete in the relatively new and rapidly evolving
Internet search infrastructure market, which presents many uncertainties that
could require us to further refine or change our business model. Our success
will depend on many factors, including our ability to:
. profitably establish and expand our new product offerings, including express
listings, sub-site listings, premium information and LookSmart Live!;
. expand and maintain our network of distribution relationships, thereby
increasing the amount of traffic using our web directory; and
. attract and retain a large number of advertisers from a variety of
industries.
Our failure to succeed in one or more of these areas may harm our business,
results of operations and financial condition.
The BT LookSmart joint venture will require a substantial investment of
resources and may not ever become profitable
Our success will depend in part upon the success of BT LookSmart, our joint
venture with British Telecommunications. We face many risks associated with BT
LookSmart, such as:
. we will recognize 50% of the net loss from the joint venture as non-operating
expense on our statement of operations. We expect the venture to incur
significant losses and require large capital expenditures for the foreseeable
future. As a result, LookSmart's revenues will be adversely impacted. We
cannot project when BT LookSmart will generate cash for us or become
profitable, if at all.
. we are obligated under the joint venture documents to make funding
contributions of up to $108 million over the first three years of BT
LookSmart's operation. If we are unable to meet our financing obligations,
our equity ownership of the joint venture will be proportionately reduced;
. the joint venture will face competition in international markets from a range
of competitors, including Yahoo!, the Microsoft Network, Alta Vista, UK Plus,
France Telecom, Deutsche Telecom, Tele Denmark, Scandinavian Online, Sonera
Plaza and other search infrastructure, media, telecommunications and portal
companies, many of which have greater capital resources and local experience
in these markets;
. the joint venture may fail to offer locally-relevant search products and
services, which would prevent it from aggregating a large base of Internet
traffic;
. the joint venture will face risks associated with conducting operations in
many different countries, including risks of currency fluctuations,
government and legal restrictions, privacy or tax laws, cultural or technical
incompatibilities and economic or political instability;
. the joint venture may be unable to aggregate a large amount of Internet
traffic and generate advertising and other revenue streams from that traffic;
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. the joint venture may fail to establish an effective management team and hire
experienced and qualified personnel in each of the countries in which it
competes; and
. we have not previously worked with British Telecommunications and may be
unable to forge an effective working relationship in the joint venture due to
differences in business goals, assessment of and appetite for risk or other
factors.
. on November 9, 2000, British Telecommunications announced that it would split
its business between two separate companies. We cannot predict what, if any,
impact this split will have on the joint venture.
Many of our advertisers are emerging Internet companies that represent credit
risks
We expect to derive an increasingly significant portion of our revenues
from the sale of advertising and listings to other Internet companies. Many of
these companies have limited operating histories and are operating at a loss.
Moreover, many of these companies have limited cash reserves and limited access
to additional capital. To reflect the environment of heightened risk, we
increased our reserves for doubtful accounts receivable in the first quarter of
2000 by $1.0 million, in the second quarter of 2000 by $759,000 and in the third
quarter of 2000 by $3.7 million. We have in some cases experienced difficulties
collecting outstanding accounts receivable and may continue to have these
difficulties in the future. If any significant part of our customer base
experiences commercial difficulties or is unable or unwilling to pay our
advertising fees for any reason, our business will suffer.
If we are unsuccessful in expanding the network of affiliates using our
directory and search services, we may be unable to increase future revenues
Our success depends on our ability to expand the network of affiliates
using our directory and search services. We have invested, and will continue to
invest, a significant amount of our human and capital resources to expand this
network. However, we cannot assure you that we will continue to grow and expand
the network of websites using our search infrastructure services on financially
favorable terms, if at all. If we are unsuccessful in doing so, the reach of our
search services, and consequently our ability to generate advertising revenues,
will be seriously harmed. In that event, our business prospects and results of
operations may deteriorate.
We face risks related to expanding into new services and businesses, including
our Listings and LookSmart Live! businesses
To increase our revenues, we will need to expand into new business areas,
particularly our express listing and sub-site listing services. Our success will
depend upon the extent to which businesses choose to use our express listing and
sub-site listings products. These products are in early stages and we cannot
predict whether they will meet projected levels of revenues in future quarters.
Also, these products will require both modification of existing software and
systems and the creation or acquisition of new software and systems. We may lack
the managerial, editorial and technical resources necessary to expand our
service offerings. For these and other reasons, these initiatives may not
generate sufficient revenues to offset their cost. If we are unable to generate
significant additional revenues from our new business areas, they may not become
profitable and may harm our results of operations and financial condition.
A failure to manage and integrate businesses we acquire could divert
management's attention and harm our operations. Acquisitions will likely also
dilute our existing stockholders
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If we are presented with appropriate opportunities, we intend to make
additional acquisitions of, or significant investments in, complementary
companies or technologies to increase our technological capabilities and expand
our service offerings. Acquisitions may divert the attention of management from
the day-to-day operations of LookSmart. In addition, integration of acquired
companies into LookSmart could be expensive, time consuming and strain our
managerial resources. It may be difficult to retain key management and technical
personnel of the acquired company during the transition period following an
acquisition. We may not be successful in integrating any acquired businesses or
technologies and these transactions may not achieve anticipated business
benefits.
Acquisitions may also result in dilution to our existing stockholders if we
issue additional equity securities and may increase our debt. For example, as a
result of the Zeal Media acquisition, which closed on October 27, 2000, we
issued shares of common stock, which diluted existing stockholders. We may also
be required to amortize significant amounts of goodwill or other intangible
assets in connection with future acquisitions, which would adversely affect our
operating results.
Our stock price is extremely volatile and investors may not be able to resell
their shares for a profit
The stock market has recently experienced significant price and volume
fluctuations, and the market prices of technology companies, particularly
Internet companies, have been extremely volatile. These broad market and
industry fluctuations may adversely affect the market price of our common stock,
regardless of our actual operating performance. You may not be able to sell your
shares for a profit as a result of a number of factors that may cause a decline
in our stock price, including:
. changes in the market valuations of Internet companies in general and
comparable companies in particular;
. quarterly fluctuations in our operating results;
. our potential failure to meet analyst expectations or informal "whisper
numbers" on a quarterly basis;
. changes in ratings or financial estimates by securities analysts;
. announcements of technological innovations, partnerships, acquisitions or new
products or services by us or our competitors; or
. conditions or trends in the Internet that suggest a decline in rates of
growth of advertising-based Internet companies.
In the past, securities class action litigation has often been instituted
after periods of volatility in the market price of a company's securities. A
securities class action suit against us could result in substantial costs and
the diversion of management's attention and resources, regardless of the
outcome.
We may be unable to address capacity constraints on our software and
infrastructure systems in a timely manner
We have developed custom, proprietary software for use by our editors to
create the LookSmart directory, and we also use proprietary and licensed
software to distribute the LookSmart directory and associated pages, and to
serve advertising to those pages. This software 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 website or the websites of our distribution affiliates
partners:
. substantial increases in editorial activity or the number of URLs in our
directory;
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. customization of our directory for syndication with particular partners;
. substantially increased traffic using our directory; and
. the addition of new features or changes in our directory structure.
If we fail to address these constraints and difficulties in a timely
manner, our advertising and other revenues may decline and our business would
likely 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 suffer.
The operating performance of our systems is critical to our business and
reputation
Any system failure, including network, software or hardware failure,
whether caused by us, a third party service provider, unauthorized intruders and
hackers, or natural disasters, that causes an interruption in our service or a
decrease in the responsiveness of the web pages that we serve could result in
reduced user traffic, a decline in revenues and damage to our reputation. Our
users, partners and customers depend on Internet service providers, or ISPs,
online service providers and other third parties for access to the LookSmart
directories. These service providers have experienced significant outages in the
past and could experience outages, delays and other operating difficulties in
the future.
In February 1999, we entered into an agreement with GlobalCenter, Inc. to
house our hardware equipment at their facilities in Santa Clara, California. We
do not presently maintain fully redundant systems at separate locations, so our
operations depend on GlobalCenter's ability to protect the systems in its data
center from system failures, earthquake, fire, power loss, water damage,
telecommunications failure, hackers, vandalism and similar events. GlobalCenter
does not guarantee that our Internet access will be uninterrupted, error-free or
secure. We have not developed a disaster recovery plan to respond to system
failures. Although we maintain property insurance and business interruption
insurance, we cannot guarantee that our insurance will be adequate to compensate
us for all losses that may occur as a result of any system failure.
If we are unable to compete effectively in the Internet search infrastructure
market, our business and profitability will suffer
We compete in the Internet search infrastructure market, which is
relatively new and highly competitive. We expect competition to intensify as
this market evolves. Many of our competitors have longer operating histories,
larger user bases, longer relationships with consumers, greater brand
recognition and significantly greater financial, technical and marketing
resources than we do. As a result of their greater resources, our competitors
may be in a position to respond more quickly to new or emerging technologies and
changes in consumer requirements and to develop and promote their products and
services more effectively than we do.
The barriers to entry into some segments of the Internet search
infrastructure market are relatively low. As a result, new market entrants pose
a threat to our business, particularly with respect to software-based search
solutions and providing Internet search services to vertical market segments. We
do not own any patented technology that precludes or inhibits competitors from
entering the Internet search infrastructure market. Existing or future
competitors may develop or offer technologies or services that are comparable or
superior to ours, which could harm our competitive position and business.
We currently face direct competition from companies that provide directory
content, search algorithms, content aggregation and licensing, targeted
advertising and online interactive service capabilities. As we expand
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the scope of our Internet services, we will compete directly with a greater
number of Internet search infrastructure providers, content aggregators and
other media companies across a wide range of different online services,
including:
. subject-specific websites where competitors may have advantages in expertise
and brand recognition;
. portals that have a branded franchise and a high frequency of repeat
visitors;
. metasearch services and software applications that allow a user to search the
databases of several directories and catalogs simultaneously; and
. category-based and directory-based services that offer information search and
retrieval capabilities.
To date, the Internet search infrastructure market has been characterized
by intense competition for consumer traffic. This has resulted in the payment of
consumer referral fees by us and others to frequently-used websites, such as
portals and ISPs. If these companies fail to provide these referrals, or the
market for these referrals becomes more competitive so that the cost of
referrals increases, our business and potential profitability could be harmed.
Recent acquisitions and strategic alliances involving our competitors could
reduce traffic on our network
A number of significant acquisitions and other alliances have been
completed or announced in the Internet search and navigation market involving
some of our competitors, including:
. CMGI's acquisition of an interest in Alta Vista and Alta Vista's planned
initial public offering;
. America OnLine's acquisition of Netscape Communications Corporation and
proposed acquisition of Time Warner, Inc.;
. Primedia, Inc.'s proposed acquisition of About.com, Inc.;
. InfoSpace's acquisition of Go2Net;
. The Walt Disney Company's (Go Network) acquisition of a significant stake in
Infoseek Corporation;
. NBCi's formation from Snap, XOOM.com, NBC.com, NBC Interactive Neighborhood,
AccessHollywood.com, VideoSeeker and a 10% equity stake in CNBC.com;
. Yahoo, Inc.'s acquisition of Geocities and strategic partnership with Google;
. Inktomi's acquisition of Ultraseek from the Go Network;
. @Home Network's acquisition of Excite, Inc.; and
. Ask Jeeves' acquisition of Direct Hit Corporation.
Although the effect of these transactions and agreements on our business
cannot be predicted with certainty, these transactions could provide our
competitors with significant opportunities to increase traffic on their websites
and expand their service offerings, which could drive down traffic for our
network. In addition, these transactions align some of our competitors with
companies, including television networks, that are
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significantly larger and have substantially greater capital, brand, marketing
and technical resources than LookSmart. As a result, these competitors may be
able to respond more quickly to new technologies and changes in consumer
requirements and to develop and promote their products and services more
effectively than we can.
We may be unable to execute our business model in international markets
A key component of our strategy is to expand our operations into selected
international markets, both through the BT LookSmart joint venture in Europe and
Asia and through our direct offerings of search and navigation services in
Australia, Canada and selected countries in Latin America. To date, we have
limited experience in syndicating localized versions of our service offerings in
international markets, and we may be unable to execute our business model in
these markets. In addition, most foreign markets have lower levels of Internet
usage and online advertising than the United States. In pursuing our
international expansion strategy, we face several additional risks, including:
. lower per capita Internet usage and online shopping rates in many countries
abroad, due to a variety of causes such as lower disposable incomes, lack of
telecommunications and computer infrastructure and questions regarding
adequate on-line security for ecommerce transactions;
. less-developed Internet advertising markets in foreign markets, which may
make it more difficult to generate revenue from the traffic on our
international directories;
. relatively small Internet markets in some countries may prevent us from
aggregating sufficient traffic and advertising revenues and scaling our
business model in those countries;
. competition in international markets from a broad range of competitors,
including Yahoo!, Alta Vista and other United States and foreign
telecommunications firms, search engines, content aggregators and portals,
many of which have greater local experience than we do;
. uncertainty of market acceptance in new regions due to language, cultural,
technological or other factors;
. our potential inability to aggregate a large amount of Internet traffic and
find and develop relationships with advertisers;
. difficulties in recruiting qualified and knowledgeable staff and in building
locally relevant products and services;
. unexpected changes and differences in regulatory, tax and legal requirements
applicable to Internet services; and
. foreign currency fluctuations.
Our failure to address these risks adequately could inhibit or preclude our
efforts to expand our business in international markets.
Our management and internal systems may be inadequate to handle the growth of
our business
Our workforce has grown from 55 employees on January 1, 1998 to
approximately 690 employees worldwide on September 30, 2000. In addition, many
members of our management team have only recently started in their current
positions. Implementation of our growth strategy requires that we hire
additional highly qualified personnel, particularly in our engineering,
international, product development and sales operations.
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Our growth has placed, and will continue to place, a significant strain on
our management, our engineering and product development staff, and our internal
accounting, operational and administrative systems. To manage future growth, we
must continue to improve these systems and expand, train, retain and manage our
employee base. If our systems, procedures and controls are inadequate to support
our operations, our expansion could be slowed. We cannot assure you that we will
be able to manage our growth effectively, and any failure to do so could harm
our business.
Our future success depends on our ability to attract and retain key personnel
Our future success depends, in part, on the continued service of our key
management personnel, particularly Evan Thornley, our Chairman and Chief
Executive Officer, and Tracey Ellery, our President. Mr. Thornley and Ms. Ellery
are husband and wife. The loss of the services of either of these individuals,
or the services of other key employees, could adversely affect our business.
LookSmart does not have employment agreements with Mr. Thornley and Ms. Ellery,
and they do not have stock options or restricted stock subject to vesting based
on continued employment.
Our success also depends on our ability to identify, attract, retain and
motivate highly skilled administrative, technical, editorial, finance and
marketing personnel. Competition for such personnel, particularly in the San
Francisco Bay area, is intense, and we cannot assure you that we will be able to
retain our key employees or that we can identify, attract and retain highly
skilled personnel in the future.
If we become subject to unfair hiring claims, we could be prevented from hiring
needed personnel, incur liability for damages and incur substantial costs in
defending ourselves
Companies in our industry whose employees accept positions with competitors
frequently claim that these competitors have engaged in unfair hiring practices
or that the employment of these persons would involve the disclosure or use of
trade secrets. These claims could prevent us from hiring personnel or cause us
to incur liability for damages. We could also incur substantial costs in
defending ourselves or our employees against these claims, regardless of their
merits. Defending ourselves from these claims could also divert the attention of
our management away from our operations.
We may face liability for intellectual property claims or information contained
in our search infrastructure services, and these claims may be costly to resolve
We make information available to end users on our search infrastructure
services, both on our website and our distribution affiliates' websites. We also
provide our distribution affiliates with custom-developed software and software
developed by others as part of our service offerings. Although we do not believe
that our website content and services infringe any proprietary rights of others,
we cannot assure you that others will not assert claims against us in the future
or that these claims will not be successful. We or our distribution affiliates
could be subject to claims for defamation, invasion of privacy, negligence,
copyright or trademark infringement, breach of contract or other theories based
on the nature and content of our information and services. These types of claims
have been brought, sometimes successfully, against online service providers in
the past. In addition, we are obligated under some agreements to indemnify other
parties as a result of claims that we infringe on the proprietary rights of
others.
Even if such claims do not result in liability to us or our distribution
affiliates, we could incur significant costs and diversion of management time in
investigating and defending against them. Our insurance may not cover claims of
this type, may not be adequate to cover all costs incurred in defense of these
claims, and may not indemnify us for all liability we incur.
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Our business prospects depend on the continued growth in the use of the Internet
Our business is substantially dependent upon continued growth in the use of
the Internet as a medium for advertising, obtaining information and commercial
transactions. Internet usage and ecommerce may not grow at projected rates for
various reasons, including:
. user inability or frustration in locating and accessing required information;
. actual or perceived lack of security of information;
. limitations of the Internet infrastructure resulting in traffic congestion,
reduced reliability or increased access costs;
. inconsistent quality of service;
. governmental regulation, such as tax or privacy laws;
. general economic problems in the United States or abroad which decreases
users' disposable income;
. uncertainty regarding intellectual property ownership; and
. lack of appropriate communications equipment.
We believe that capacity constraints caused by growth in the use of the
Internet may, unless resolved, impede further growth in Internet use. Further,
the adoption of the Internet for commerce and communications, particularly by
those individuals and companies that have historically relied upon traditional
means of commerce and communication, generally requires the understanding and
acceptance of a new way of conducting business and exchanging information.
Companies that have already invested substantial resources to conduct commerce
and exchange information through other means may be particularly reluctant or
slow to adopt a new Internet-based strategy that may make their existing
personnel and infrastructure obsolete. If any of the foregoing factors affects
the continuing growth in the use of the Internet, our business could be harmed.
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 Federal Trade Commission and government agencies in some states and
countries have been investigating some Internet companies, and lawsuits have
been filed against some Internet companies, regarding their use of personal
information. The European Union has adopted a directive that imposes
restrictions on the collection and use of personal data, guaranteeing citizens
of European Union member states various rights, including the right of access to
their data, the right to know where the data originated and the right to
recourse in the event of unlawful processing. Any laws imposed to protect the
privacy of Internet users may affect the way in which we collect and use
personal information. We could incur additional expenses if new regulations or
court judgments regarding the use of personal information are introduced or if
any regulator chooses to investigate our privacy practices.
As is typical with most websites, our website places information, known as
cookies, on a user's hard drive, generally without the user's knowledge or
consent. This technology enables website operators to target specific users with
a particular advertisement and to limit the number of times a user is shown a
particular advertisement. Although some Internet browsers allow users 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 or
technically proficient enough to customize these options. In addition, some
Internet commentators, 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 advertisers and sponsors,
which could result in a decline in our revenues.
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We and some of our partners retain information about our users. If others
were able to penetrate our network security and gain access to, or in some other
way misappropriate, our users' information, we could be subject to liability.
These claims could result in litigation, our involvement in which, regardless of
the outcome, could require us to expend significant time and financial
resources.
New tax treatment of companies engaged in Internet commerce may adversely affect
the Internet industry and our company
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 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. However, new or revised taxes and, in particular, sales taxes, would
likely increase our cost of doing business and decrease the attractiveness of
advertising and selling goods and services over the Internet. Any of these
events would likely have an adverse effect on our business and results of
operations.
Future sales of our securities may cause our stock price to decline
The market price of our common stock could decline as a result of sales of
substantial amounts of our common stock in the public market, or the perception
that such sales could occur. As of November 3, 2000, approximately 44.2 million
shares of common stock were held by non-affiliates and approximately 45.8
million shares were held by affiliates, all of which are currently available for
resale in the public market without registration, subject to compliance with
Rule 144 under the Securities Act. Moreover, as of November 3, 2000, the holders
of up to 42.2 million shares of common stock and warrants to purchase up to
approximately 2.1 million shares of common stock had rights to require us to
register those shares under the Securities Act.
In addition, the Chess Depository Interests, or CDIs, which are publicly
traded on the Australian Stock Exchange under the symbol "LOK", are exchangeable
into shares of LookSmart common stock at a ratio of 20 CDIs per share of common
stock. Holders of CDIs may decide to exchange their CDIs for shares of LookSmart
common stock at any time. In that event, the exchanged shares of common stock
may be immediately available for resale at the option of the holders in the
Nasdaq National Market, which could depress the Nasdaq market price of LookSmart
common stock. As of October 31, 2000, the CDIs registered for trading on the
Australian Stock Exchange were exchangeable into an aggregate of approximately
11.7 million shares of common stock.
These resales of common stock in the Nasdaq National Market, or the
perception that they may occur, could cause our stock price to decline. These
events may also make it more difficult for us to raise funds through future
offerings of common stock.
Directors, officers and significant stockholders have substantial influence over
LookSmart, which could prevent or delay a change in control
As of November 3, 2000, our executive officers, directors and significant
stockholders and the funds for whom they act as general partner, collectively
owned approximately 51% of the outstanding shares of LookSmart common stock. If
these stockholders choose to act or vote together, they will have the power to
control matters requiring stockholder approval, including the election of our
directors, amendments to our charter and approval of significant corporate
transactions, including mergers or asset sales. This concentration of ownership
may have the effect of discouraging others from making a tender offer or bid to
acquire LookSmart at a price per share that is above the then-current market
price.
The anti-takeover provisions of Delaware's general corporation law and
provisions of our charter and bylaws may discourage a takeover attempt
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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, could discourage potential acquisition proposals and could delay or prevent
a change of control.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. The Company's exposure to market risk for interest rate
changes relates primarily to its short-term investments. The Company had no
derivative financial instruments as of September 30, 2000 or 1999. The Company
invests in debt instruments of high-quality corporate issuers with original
maturities greater than three months and current maturities less than twelve
months. The amount of credit exposure to any one issue and issuer is limited.
Foreign Currency Risk. International revenues from the Company's foreign
subsidiaries were less than 10% of total revenues in the quarters ended
September 30, 2000 and 1999, and were derived entirely from our Australian
operations. The Company's international business is subject to risks typical of
an international business, including but not limited to differing economic
conditions, changes in political climate, differing tax structures, other
regulations and restrictions and foreign exchange rate volatility, partially the
exchange rate between the Australian dollar and the United States dollar. The
effect of foreign exchange rate fluctuations on the Company for quarters ended
September 30, 2000 and 1999 were not material.
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PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(d) Use of Proceeds.
On August 20, 1999, the Securities and Exchange Commission declared
effective our registration statement on Form S-1 (File No. 333-80581)
registering the initial public offering of 8,855,000 shares of our common stock
at an offering price of $12.00 per share. The initial public offering was
managed by Goldman, Sachs & Co., BancBoston Robertson Stephens and Hambrecht &
Quist. Gross proceeds of the offering, including the underwriters' exercise of
the over-allotment option, were approximately $106.3 million. Net proceeds to
LookSmart for the offering, after deducting commissions, fees and expenses
related to the offering, were approximately $96.9 million. As of September 30,
2000, a portion of the net proceeds had been used for general corporate
purposes, including working capital, marketing and promotional activities,
expanded operations, new product development and increased personnel. The
remaining proceeds were invested in short-term investments in order to meet
anticipated cash needs for future working capital.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(1) Exhibits.
Exhibit 27 Financial Data Schedule
(2) Current Reports on Form 8-K.
The Company filed no Current Reports on Form 8-K during the quarter ended
September 30, 2000.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 2000 LOOKSMART, LTD.
By: /s/ Ned Brody
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Ned Brody
Chief Financial Officer
(Principal Financial Officer)
By: /s/ Robert Mally
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Robert Mally
Vice President of Finance
and Controller (Principal Accounting Officer)
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