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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
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 No. 000-26357
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LOOKSMART, LTD.
(Exact name of Registrant as specified in its charter)
Delaware 7373 13-3904355
(State or other jurisdiction
of (Primary Standard Industrial (I.R.S. Employer
incorporation or
organization) Identification No.) Identification No.)
625 Second Street, San Francisco, CA 94107
(415) 348-7000
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
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Securities registered pursuant to Section 12 (b) of the Act:
None
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, par value $.001 per share
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing price of common stock on March 23, 2000,
was approximately $1,286,216,000. Shares of voting stock held by each officer
and director and by each person who owns 5% or more of the outstanding voting
stock have been excluded in that such persons may be deemed to be affiliates.
This determination of affiliate status is not necessarily a conclusive
determination for other purposes. As of March 23, 2000, 87,899,230 shares of
the registrant's common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III of this Form 10-K is incorporated by
reference to the definitive proxy statement for the annual meeting of
stockholders of the company which will be filed no later than 120 days after
December 31, 1999.
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TABLE OF CONTENTS
PART I
Page
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ITEM 1. BUSINESS...................................................... 3
ITEM 2. PROPERTIES.................................................... 24
ITEM 3. LEGAL PROCEEDINGS............................................. 24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 24
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.......................................... 25
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.......................... 27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................... 27
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.... 39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL
DISCLOSURE................................................... 60
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 61
ITEM 11. EXECUTIVE COMPENSATION........................................ 61
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................... 61
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 61
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K........................................................... 62
2
PART I
This Annual Report on Form 10-K contains forward-looking statements that
involve risks and uncertainties. Discussions containing forward-looking
statements may be found in the material set forth under "Business,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and in other sections of the report. We use words such as
"believes", "intends", "expects", "anticipates", "plans", "may", "will" and
similar expressions to identify forward-looking statements. You should not
place undue reliance on these forward-looking statements. Our actual results
could differ materially from those anticipated in the forward-looking
statements for many reasons, including the risks described below in the
section entitled "Risk Factors" and elsewhere in this report.
ITEM 1. BUSINESS
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 approximately 100,000 partners and affiliates worldwide. Our search
partners choose LookSmart because our search solutions are developed to
satisfy their various strategic goals. First and foremost, 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. Second, we craft
our search solutions to maximize the generation of revenue for our partners.
Third, because of the scale of our distributed search solution network, 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 are able to deploy our search solutions in a
cost-effective and scalable manner.
Our domestic network of search partners and affiliates includes:
. Internet portals such as Microsoft, Excite@Home, Alta Vista and Go2Net;
. media companies such as Time Warner, Sony, Cox Interactive Media and
MacroMedia/Shockwave;
. Internet services providers, or ISPs, such as US West, IBM.net,
RoadRunner, Flashnet and Prodigy; and
. approximately 95,000 personal and small business websites.
BT LookSmart, our joint venture with British Telecommunications, is
primarily responsible for the expansion of our international network of
partners and country-specific search directories in Europe and Asia, including
the United Kingdom, the Netherlands, Hong Kong, Singapore, Malaysia, New
Zealand, Japan and Korea. We also maintain the www.looksmart.com website,
primarily as a showcase for our search products and as a destination for users
who wish to search directly with LookSmart.
In January 2000, more than 45 million unique users accessed the websites of
our distribution partners and www.looksmart.com, according to Media Metrix.
This figure is calculated by combining the unduplicated reach of the websites
of our search partners with the unduplicated reach of our www.looksmart.com
properties. On a duplicated basis, our reach exceeds 100 million users per
month.
Our search solutions consist of a robust suite of search products. At the
core of our search solutions is a directory of high-quality, granular content.
Through the use of technology and human editors, we have assembled what we
believe to be the largest collection of high-quality, granular content on the
Internet. Our directory currently includes a collection of over 1.5 million
links to, and reviews of, high-quality websites organized into more than
100,000 categories. We exclude hate and pornographic content from our
directory. We provide various
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methods to Internet users to search our solutions, including browsing the
directory by categories, searching the directory by keyword and asking
questions in a natural language, interactive format to our team of specialized
Internet editors.
Industry Background
The emergence and wide acceptance of the Internet has fundamentally changed
how millions of people worldwide share information, communicate and conduct
business. International Data Corporation estimates that the number of Internet
users worldwide will increase from approximately 142 million in 1998 to
approximately 399 million by the end of 2002. IDC expects the total number of
URLs to grow from 925 million in 1998 to 8 billion by 2002. This includes
"suffixed" pages, which are separate URLs within individual websites. We
believe this increase is leading to a greater amount of highly specific
content on the Internet. Major factors driving this growth in Internet usage
and content include the increasing familiarity with and acceptance of the
Internet by businesses and consumers, the growing number of personal computers
in homes and offices, the ease, speed and lower cost of Internet access and
improvements in network infrastructure. These factors make the Internet
accessible to inexperienced users as well as the technologically
sophisticated. The growth in the number of Internet users has also led to the
emergence of the Internet as a powerful advertising and commerce medium.
Forrester Research estimates that total spending on Internet advertising in
the United States will grow from $1.5 billion in 1998 to nearly $11 billion in
2002.
The Search Challenge
The massive volume and growth of granular content on the Internet has
created the need for an organizing layer that can successfully match end users
with content providers. This organizational challenge, which we call the
"search challenge", has led to the development of several Internet services,
including directories and search engines, designed to help users locate
information. These services also seek to enable content providers, including
website owners, Internet communities, advertisers and sellers of goods and
services, to reach their target audiences.
We believe that most Internet organization efforts to date have failed to
fully meet this challenge. Traditional Internet directories often lack focused
and relevant category structures, have limited content and contain many links
to "dead", outdated or irrelevant websites. Search engines, which use software
to locate websites based on user-entered keywords, often generate large sets
of results but typically cannot determine website quality. Moreover, search
engines often have limited capacity to determine the relevance of websites to
a query, have poor "ranking algorithms" to order results, do not contain
recently published websites and fail to respond to "dynamic" or frequently
changing material. We believe Internet users are demanding smarter search
capabilities and better organized content that will allow them to find
granular, deeply specialized and local content.
The Search Infrastructure Challenge
We believe that search is critical to most Internet users' ability to use
of the Internet productively and effectively. To provide a satisfying user
experience, many portals, ISPs, media companies and other website operators
have recognized the need to provide sophisticated search functionality on
their websites. We believe that as these companies invest more heavily in
adding content and functionality to their websites, they will have relatively
fewer resources to devote to creating and maintaining relevant and focused
directory and search services. At the same time, the complexity and resources
needed to provide superior directory and search capabilities are increasing.
Specialized expertise is needed to organize the growing amount and specificity
of content available on the Internet. Search technologies are becoming
increasingly sophisticated, because of the need to integrate internal company
data, information from across the company's website properties and data from
external Internet websites into search results. Therefore, the editorial and
technical demands for companies to maintain high quality directories and
advanced search functionality has grown significantly. As a result, many large
companies, portals and websites are finding it more effective and efficient to
outsource their Internet search and directory infrastructure.
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The Advertising Challenge
The rapid emergence of Internet advertising and commerce has created new
challenges for businesses seeking to advertise and sell their products and
services online. As businesses try to attract qualified people to their
website through online advertising, they need to find a means of both
aggregating a large volume of traffic through their websites and targeting
their advertising message according to individual users' interests. However,
the ability to effectively target an advertising message to Internet users
requires specialized capabilities. Therefore, expanding website traffic and
developing targeting capabilities is a key element of the online advertising
challenge.
In addition, many companies have little understanding of, or experience in,
monetizing their website traffic through advertising. Finding firms who wish
to advertise on a company's website, selling effective advertising products to
them, serving the advertisements and billing the clients requires a scale in
activities that can discourage website owners from conducting these tasks
themselves. Online companies can derive significant benefits from outsourcing
this function to a specialized service in order to monetize their traffic and
maximize their advertising revenues.
The LookSmart Solution
We have created a powerful suite of search solutions to enable our partners
and affiliates to achieve their objectives of providing a superior user
experience and maximizing the revenues from their traffic. We have assembled
what we believe to be the largest collection of high-quality, granular content
on the Internet, organized in a categorical, easy-to-search directory format.
We have also developed and partnered with technology leaders to develop
flexible search capabilities that can be customized to our partners'
specifications. Finally, we have developed an interactive search solution
which enables users to access the expertise of our web-searching experts. In
developing this full set of search solutions, we believe we are creating a
highly scalable asset that can be distributed to a large number of Internet
users through our network of distribution partners and through our Internet
properties. In the process, we seek to address the challenges faced by users,
content providers, advertisers and vendors.
Our Search Solution
We provide search solutions that enable users to find useful information
quickly. Our services allow users to choose between browsing the directory
through an intuitive category search path, inputting keywords in a search box
or interacting with our editors to find the most relevant sites quickly.
Comprehensive Content. The LookSmart directory currently contains over 1.5
million unique URLs in over 100,000 categories. We have developed locally
relevant and culturally sensitive Internet directories for Canada, Australia
and some Latin American countries, as well as over 70 local areas in the
United States. We have also developed specialized directories for several
countries in Europe and Asia, which we have licensed to BT LookSmart, our
joint venture with British Telecommunications. BT LookSmart plans to offer
these and other directory services for countries in Europe and Asia, aside
from China.
High-Quality Content. We focus on including only authoritative, up-to-date,
categorized content in our directory. Our team of over 200 editors includes
taxonomists, copy editors, subject specialists, maintenance editors and
generalist editors. Our editors use proprietary and licensed software products
that help them find, categorize, index and rate high-quality websites. They
also review the directory regularly to check whether websites are active and
still relevant. Additionally, they exclude hate and pornographic websites from
our directory.
Easy-to-Navigate Content. The LookSmart directory is organized to provide
relevant search results for both category-based and keyword search. Our
navigation interface allows a user to follow a search path into sub-categories
and sub-sub-categories visually on the screen, enabling the user to see not
only which path was
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chosen, but also those which were not. We believe that this is a critical
element in the trial and error process that most users undertake to find
material. Our keyword search brings users directly to website results. All of
our navigation results include a brief review of each website to help guide
users.
LookSmart Live! In July 1999, we introduced a service that enables users to
directly contact our editors to get assistance with their Internet search and
related activities. We developed this feature in response to consistent data
from our qualitative research that suggests that Internet users, particularly
new users, often "get stuck" and would greatly value assistance.
Our Search Infrastructure Solution
Our ability to categorize and organize highly granular content from the
Internet and integrate it with internal and company-specific information
allows us to offer a variety of Internet infrastructure solutions to our
business partners. We have developed and partnered with technology providers
to offer customized versions of our directory and customized search algorithms
to our affiliates. Our ability to tailor search solutions according to the
specifications of our partners is an important part of LookSmart's value
proposition to our partners. We work with our partners to customize our search
solutions to meet the particular needs of their website strategy and core
audience.
Our outsourcing Internet infrastructure solution has three principal
benefits to our distribution affiliates. First, we enable our affiliates to
obtain customized private label search functionality without expending
resources and expertise to develop and maintain a comprehensive Internet
directory and search technology. Second, inclusion in our network enables our
partners to gain exposure to a large number of Internet users and advertisers.
Third, we build our search solutions to maximize the generation of revenue for
our partners.
Our Advertising Solution
We launched www.looksmart.com, the showcase site for our LookSmart
directory, in October 1996. We leverage our database by syndicating, licensing
and distributing our search solutions to leading Internet portals, ISPs, media
companies and other websites, including Alta Vista, Excite@Home, Go2Net,
Microsoft Network, Netscape Netcenter, Shockwave (a Macromedia company) and
Time Warner. According to Media Metrix, in January 2000 over 45 million unique
users viewed the websites of our distribution partners and our
www.looksmart.com website. As a result of this substantial Internet user base,
we are able to offer advertisers the opportunity to reach Internet users on a
broad scale.
In addition, by offering advertisers the ability to place their
advertisements on category and keyword results pages, advertisers are able to
find their target audience more effectively. Rather than tracking individual
users' Internet page views or matching this user data with personal
information about the user, our targeted advertising solution is achieved by
placing contextually relevant advertisements on the pages and in the
categories of information the Internet user has specifically requested from
our search solutions.
The LookSmart Strategy
Our strategy is to establish LookSmart as the leading search infrastructure
provider to Internet portals, ISPs, media companies and other websites
worldwide. We seek to address our partners' search needs through our directory
and search solutions and derive multiple revenue streams by leveraging these
core assets. The key elements of our growth strategy include the following:
Expand Our Collection of High-Quality, Granular Content
We intend to expand both the number of high-quality URLs included in our
directory as well as the number of categories into which we classify the URLs.
Our mission to be the largest provider of granular information on the Internet
requires us to continually improve the content in our existing categories by
including new websites, communities and commerce environments, deleting
outdated links and updating editorial reviews. We also plan
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to expand the type of content in our directory, including new content in our
Australian, Canadian and Latin American databases, expanding our broadband
directory and providing information for wireless Internet devices. Our joint
venture with British Telecommunications, BT LookSmart, plans to enhance our
existing directories and develop new directories for selected countries in
Europe and Asia. In order to expand these directories, we plan to increase the
number of Internet editors that we have worldwide and leverage their efforts
with advanced productivity tools.
Broaden Our Network of Affiliates, Advertisers and Ecommerce Partners
We intend to continue building a network of portals, media companies, ISPs
and other websites that use our directory and search infrastructure solutions.
At the same time, we plan to capitalize on our expanded reach to attract
additional advertisers and ecommerce partners who wish to reach a larger, more
targeted audience.
Utilize LookSmart Directory and Search Solutions to Drive Multiple Revenue
Streams
Our goal is to leverage our unique assets--the LookSmart directory and
search solutions--and monetize them in several ways. We are targeting the
convergence of three market opportunities: online advertising and syndication,
licensing, and ecommerce/distribution. We plan to continue monetizing our
assets through these revenue opportunities, as well as to create additional
revenue streams, including international sources and new ecommerce and
distribution opportunities.
Pursue Strategic Acquisitions and Alliances
We plan to pursue acquisitions and alliances to strengthen our technology,
broaden our audience reach, capture new distribution channels or open new
revenue streams. In addition, we may seek to acquire businesses or develop
alliances which will further expand our syndication, licensing and
ecommerce/distribution services.
Expand into Select International Markets
As a company with relevant operational experience outside the United
States, we believe we are well positioned to enter major international markets
in a locally relevant, culturally-sensitive manner. We plan to expand our
directory and search solutions in selected markets internationally, both
through direct offerings of our services to Internet users in Australia,
Canada and selected countries in Latin America and through the BT LookSmart
joint venture in Europe and Asia.
The LookSmart Directory
The LookSmart directory has been structured to include "all of the useful
stuff and none of the junk". The database is organized in order to enable
users to follow intuitive category and sub-category "paths" to find their
desired content or to retrieve it by typing a keyword in a search box.
We create this directory database using a combination of proprietary and
licensed software and a highly structured Internet editorial team. Our
editorial teams are located in San Francisco, Amsterdam, Copenhagen, Melbourne
and Montreal. Our software includes a sophisticated desktop tool that enables
editors to find, review, describe and categorize websites and to check whether
websites is currently active and available. The systems we have developed
enable our editors to perform five core processes:
Find the Content
Our editors use a range of automated search technologies, other websites,
website submissions from website owners/builders, off-line data sources and
other methodologies to find the content our users may require.
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Select the Content
In finding useful content, our editors also encounter a lot of "junk",
material that is unlikely to be useful to our users. For example, a user
searching through traditional Internet directories for material on surgery for
breast cancer is likely to come across material that is either commercial
material, material related to cosmetic surgery, pornographic material, or
material from sources with limited medical authority. Our editors select and
place content for each of over 100,000 categories according to parameters that
our taxonomy team maintains. Also, the editors will often organize the
websites to enable the user to find the most generally useful or authoritative
source first and view the more specialized or marginal sources later.
Organize the Content
Our team of full-time taxonomists, primarily library science and
information science specialists, create and frequently modify our category
taxonomy to ensure that it is logical, current and intuitive.
Describe the Content
The end product that users typically seek from a navigation service is a
list of website links. Our editors facilitate the search process by providing
succinct descriptions of up to 20 words for every listed website to assist
users in determining which websites contain content most relevant to their
search.
Maintain the Content
Our editors regularly review user requests and content availability to add
new categories and new websites for existing categories. We also use a
combination of software and editorial intervention to minimize inactive links
in the database. Websites in each category are reviewed according to a
schedule that is appropriate to the subject matter. For example, we update our
collection of material related to the current news much more frequently than
we update our material on historical subjects.
Advertising and Syndication of Our Directory and Search Solutions
In 1999, $22.1 million or 45% of our revenues derived from advertising and
syndication of our directory and search solutions. We offer a full suite of
search solutions and often sell and serve the advertising on our partners'
websites. In most cases we offer a complete search solution where we create a
unique HTML environment for the client's search feature, host the service,
sell advertising on those pages and share advertising revenue with the client.
We believe that there are three factors that drive advertising business to
LookSmart:
. we deliver highly targeted advertising based on the specific content
category on the page;
. we create a quality environment with all sites selected by expert web
editors and exclude all hate and pornography; and
. advertisers are attracted to the scale we have achieved through our
distribution network of search solutions customers.
Our advertising sales were handled through Softbank Interactive Marketing
until October 1997 and by DoubleClick, Inc. from October 1997 through mid-
1998. In an effort to maintain stronger relationships and loyalties with our
advertisers and to reduce advertising sales costs as a percentage of revenues,
in mid-1998 we created our own sales organization, which now consists of a
national sales team of 29 personnel located in San Francisco and New York. We
plan to expand the size of the team and the location of the offices
commensurate with traffic expansion.
The following is a list of some of the advertisers that have recently
advertised on our www.looksmart.com website or the websites of our
distribution affiliates: Amazon.com, Ameritech, Barnes & Noble, Bell Atlantic,
eBay, Farmers Insurance, JC Penney, Jenny Craig, LowestFare, Microsoft,
Nordstrom, Office Max and Providian Financial.
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Licensing of Our Directory and Search Solutions
In 1999, $19.3 million or 39% of our revenues derived from licensing of our
directory and search solutions. We receive revenue from licensing our existing
directory and customizing our directory based on the specifications and needs
of our customers. Clients who license our directory include Microsoft and
Excite@Home. We have built 25 country databases and established partnerships
abroad, most recently with British Telecommunications to form BT LookSmart, an
equally-owned joint venture which will provide search and directory services
in Europe and Asia.
Ecommerce and Distribution
In 1999, $7.5 million or 15% of our revenues derived from our ecommerce and
distribution activities. Many online businesses have elected to be included in
the LookSmart search network, because it allows them to reach a potential
audience of tens of millions of Internet users. Our "Buy It On The Web"
shopping website promotes and sells a range of consumer products, including
the "As Seen on TV" product line promoted by our partner Guthy Renker
Corporation. We plan to establish additional distribution partnerships with a
range of other businesses in order to expand our distribution-based revenue
streams. We also intend to work with existing and new partners to explore ways
to leverage our distribution network and create new revenue streams.
International Operations
LookSmart has established international operations to meet worldwide demand
for improved search infrastructure on the Internet. Central to our
international efforts is our ability to localize our database for individual
markets in order to create a more locally relevant, culturally sensitive
offering. We currently have editorial teams located in San Francisco
(primarily for United States, Latin American, Japanese and Korean services),
London (primarily for English-language European services), Melbourne
(primarily for Australian, British and New Zealand services), Montreal
(primarily for Canadian services) and Copenhagen and Amsterdam (for non-
English European services).
Our recently-formed joint venture, BT LookSmart, plans to enhance existing
local directories, build new country-specific directories and provide search
solutions for selected countries in Europe and Asia. BT LookSmart is equally
jointly owned by LookSmart and British Telecommunications and will seek to
provide Internet search solutions and specialized locally relevant directories
in a number of countries across Europe and Asia. See "Business--Risk Factors--
The BT LookSmart joint venture will require a substantial investment of
resources and may not ever become profitable".
Network of Distributors and Affiliates
We have actively pursued relationships with portals, ISPs, media companies
and other websites and regard these relationships as key drivers of growth in
traffic and revenue. These relationships include the following:
British Telecommunications
In February 2000, LookSmart and British Telecommunications established a
joint venture, BT LookSmart, which plans to offer locally relevant, culturally
sensitive Internet directories for selected countries in Europe and Asia. We
licensed to BT LookSmart our websites for several countries, including the
United Kingdom, the Netherlands, Singapore, Malaysia and New Zealand, as well
as our directories for several countries, including Japan and Korea. BT
LookSmart intends to expand these existing directories and build new ones for
selected countries in Europe and Asia. The joint venture plans to offer its
services to British Telecommunications' established base of Internet customers
in Europe and Asia.
Cox Interactive Media
We have a strategic alliance with Cox Interactive Media relating to local
websites, local navigation services and local content. Our United States
directory is prominently placed on all 23 of Cox's local city sites, such as
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www.accessatlanta.com. Cox Interactive Media, using its own editorial staff,
provides the local content for over 70 city markets for our United States
directory database using a licensed copy of our proprietary Editorial Support
System.
Excite@Home
In June 1999, we entered into a three-year licensing agreement with
Excite@Home Corporation under which Excite@Home licensed our directory
databases for use on the www.excite.com website and other properties. Under
the agreement, we update the database periodically.
Microsoft
In December 1998, we entered into a five-year licensing agreement with
Microsoft Corporation under which Microsoft licensed our directory database
for use on the www.msn.com website and other properties. The agreement is
terminable by either party on six months' notice at any time after June 5,
2000. Under the agreement, we provide Microsoft with custom-tailored Internet
directory content according to Microsoft's requests in six-month increments.
Time Warner
In January 2000, we entered into an agreement with Time Warner, Inc. under
which we agreed to syndicate our search service across Time Warner Internet
properties including www.CNN.com, www.CNNfn.com, CNNSI, www.warnerbros.com
(Warner Bros.), www.Entertaindom.com and www.EW.com (Entertainment Weekly).
Competition
We compete in markets that are new, intensely competitive, highly
fragmented and rapidly changing. We compete on the basis of several factors,
including the quality of content and the ease of use of online services. In
the licensing and syndication market, there are additional factors such as
performance, scalability, price, and relevance of results. The number of
companies and websites competing for users, Internet advertisers' and
ecommerce marketers' spending has increased significantly. With no substantial
barriers to entry in these markets, we expect this competition to continue to
increase. Competition may also increase as a result of industry consolidation.
We face direct competition from companies that provide several types of
Internet services, as illustrated in the following table.
Category Focus Example Competitors
-------- ----- -------------------
Internet content Internet search, content AOL, Yahoo!, Netscape
retrieval aggregation and content Open Directory, Inktomi,
licensing Ask Jeeves, Alta Vista,
Lycos NBCi, Go Network,
GoTo.com
Internet advertising Demographically targeted and Internet advertising
content-targeted advertising networks like DoubleClick
and 24/7 Media; Internet
navigation firms with
similar content targeting
capabilities like AOL,
Yahoo!, and Lycos
Internet outsourcing Outsourcers of Internet Inktomi, InfoSpace.com,
search solutions, Internet Netscape Open Directory,
portal or website Ask Jeeves, GoTo.com,
enhancement content MyWay.com, NBCi, Lycos
Online commerce Small vendors Internet and TicketMaster-CitySearch,
enabling companies transaction enabling AOL's Digital Cities,
Sidewalk, Go2Net, iMall
and Hypermart
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See "Business--Risk Factors--If we are unable to compete effectively in the
Internet navigation market, our business and profitability will suffer".
Technology
One of our principal assets is our internally-developed and licensed
software for creating and distributing the LookSmart directory and search
solutions. In addition, we use a variety of hardware and communications
technologies to distribute and maintain our business.
Editorial Support System
We have developed a proprietary software application, the Editorial Support
System, used by our editors to discover, edit, and categorize websites into
the LookSmart database. This system undergoes frequent revision and upgrade
and over 200 editors can use the application simultaneously. In addition to
the Editorial Support System, we have developed several proprietary algorithms
which enable us to extract data from the database, publish this data in
various editions of the directory and perform routine maintenance on the
database, such as deadlink checking.
The Editorial Support System also provides various statistical and
reporting functions, including editorial productivity levels and work quality,
and identifies trends in user preferences. We have recently enhanced the
system to include capabilities for Asian characters and languages.
Taxonomy and Search
We publish our data in a proprietary and unique set of categories in a
specific taxonomy. This taxonomy has over 100,000 categories. We have
developed proprietary search technology to search this database and return
relevant answers to users. In addition, by integrating keyword search software
from Fast Search and Transfer into our systems, we can create custom search
solutions for our partners' data and content. Through our partnership with
Inktomi, our partners can create and manage customized directories, utilizing
the breadth, depth and ongoing development of Looksmart's core directories.
Server Architecture
We believe we have developed a proprietary, dynamic and scalable server
software architecture that allows us to support our ISP partners by serving
custom versions of the ISP's home page or any other page on the ISP's website
as part of our distribution of directory content. In January 1999, we signed a
license agreement with Engage Technologies to license their Accipiter
advertising server technology. We converted our advertising serving
functionality from an internal proprietary application to the Accipiter
technology effective in March 1999.
GlobalCenter
In February 1999, we signed an agreement with GlobalCenter, Inc. to provide
co-location, Internet connectivity, and maintenance of our hardware equipment
at GlobalCenter's facilities in Santa Clara, California. GlobalCenter provides
comprehensive facilities management services, including human and technical
monitoring of all production servers, 24 hours per day, seven days per week.
Marketing
Marketing activities will be important in our efforts to build traffic and
attract additional advertisers, syndication affiliates and ecommerce partners.
We have initiated a multi-tiered marketing strategy to support activities
related to key aspects of our business model. We have identified the following
primary targets for our marketing programs:
. the advertising trade, including advertising agency media planners who
plan and buy online advertising for their clients;
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. business partners, including leading ISPs, media companies, portals and
other websites that use LookSmart on a branded, co-branded or unbranded
basis to enhance the search experience of their customers; and
. Ecommerce websites and online marketers of products and services that
seek to be reviewed and included in LookSmart's database of URLs in
order to gain online reach through our partner network.
Employees
We had 151 employees at the end of 1998 and approximately 535 at the end of
1999. We have never had a work stoppage, and none of our employees is
represented by a labor union. We consider our relations with our employees to
be good.
12
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. If any of the following risks actually occur, our
business, financial condition or 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. As of December 31, 1999, we had an accumulated deficit of
approximately $87.9 million. We expect to have increasing 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 and capitalize on
new sources of revenue and on the level of 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 strategic distribution partners;
. fund new product development and enhance the functionality of our search
and navigation services; and
. acquire complementary technologies and businesses.
As a result, we expect that our operating expenses and non-operating losses
will increase significantly in the near term and, consequently, we will need
to generate significant additional revenues to achieve profitability. Even if
we do achieve profitability, we may not be able to sustain or increase
profitability on a quarterly or annual basis.
Our quarterly revenues and operating results may fluctuate due to many
factors, each of which may negatively affect our stock price
Our quarterly operating results may fluctuate significantly as a result of
a variety of factors that could affect our revenues in any particular quarter.
These factors include:
. the level of user traffic on our and our affiliates' 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 licensing and advertising
contracts;
. the level and timing of our entry into new contracts for Internet
infrastructure building, database 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;
. 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 the Microsoft contract. 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 may
be skewed on a quarter-to-quarter basis.
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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, including
costs related to acquisitions and integration of technologies or businesses.
Due to the above factors, we believe that period-to-period comparisons of
our operating results are not necessarily meaningful. You should not rely on
period-to-period comparisons 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 will 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 until
the end of fiscal 2000, unanticipated developments in the short term, such as
the acquisition of businesses with high negative cash flows, may also require
additional financing. In any case, we will 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
technology and 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 we need will be available on terms favorable to us,
or at all.
Our business prospects depend on the use of the Internet as an advertising
medium and our ability to generate advertising revenues
For the quarter and year ended December 31, 1999, advertising and
syndication revenues accounted for 55% and 45% of our total revenues. We
expect that revenues from advertising and syndication will continue to
represent a significant portion of our total revenues for the foreseeable
future. 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. We expect
downward pressure on advertising prices in the industry generally 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 not continue to spend money on Internet
advertising. Acceptance of the Internet among advertisers will depend, to a
large extent, on the level of Internet usage by consumers and upon growth in
the commercial usage of the Internet.
In addition, advertising on the Internet is at an earlier stage of
development in international markets compared to the United States. We intend
to expand our overseas operations and will therefore be subject to the greater
uncertainties associated with our reliance on advertising revenues from
international operations.
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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.
Intense competition for advertising revenues exists among high-traffic
websites, which results in significant price competition. Currently, there are
a variety of pricing models for selling advertising on the Internet. Several
of the most widely used pricing models are based on the number of impressions
or clickthroughs, the duration over which the advertisement is displayed or
the number of keywords to which the advertisement will be 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
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.
Our management and internal systems may be inadequate to handle the growth of
our business
Since January 1, 1998, our workforce has grown substantially, from 55
employees at that date to approximately 535 employees on December 31, 1999. In
addition, many members of our management team have only recently started in
their current positions, including our Senior Vice President, Engineering and
Senior Vice President, Finance. We also need to hire employees to fill several
key positions, including Senior Vice President, Marketing and Vice President,
International. Implementation of our growth strategy requires that we hire
additional highly qualified personnel in the near term, particularly in our
engineering, administration, product development and sales operations.
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.
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 after June 5, 2000, either party may terminate the
agreement for any reason on six months' notice. For the quarter and year ended
December 31, 1999, revenues from Microsoft under this agreement accounted for
$4.7 million (26%) and $18.8 million (39%) 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. Microsoft has the right to use our database during the
term of the agreement and, after the agreement is terminated, 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. Microsoft may not sublicense its
rights to a specified group of companies, which includes some of our
competitors.
Our revenues and income potential are unproven and our business model is
continuing to evolve
We were formed in July 1996 and launched our search and navigation service
in October 1996. Because of our limited operating history, it is extremely
difficult to evaluate our business and prospects. You should evaluate
15
our business in light of the risks, uncertainties, expenses, delays and
difficulties associated with starting a 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:
. expand and maintain our network of distribution relationships, thereby
increasing the amount of traffic to Internet properties using our search
services;
. attract and retain a large number of advertisers from a variety of
industries; and
. profitably establish and expand our service offerings, including
ecommerce distribution and LookSmart Live!
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
We face many risks associated with the BT LookSmart joint venture:
. we will recognize 50% of the net income or loss from the joint venture
as non-operating income or expense on our statement of operations. In
the early years of operation we expect the venture to incur significant
losses and require large capital expenditures. As a result, LookSmart's
earnings will be adversely impacted. We cannot project when BT LookSmart
will reach cash flow break-even or become profitable, if at all.
. we may be unable to raise funds to meet our financing obligations, in
which case 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!, Microsoft Network, Alta Vista,
UK Plus, France Telecom, Deutsche Telecom, Tele Denmark, Scandinavian
Online, Sonera Plaza and other American and foreign search engines,
content aggregators and portals, some 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's success will depend on its ability to aggregate a
large amount of Internet traffic and monetize that traffic through
advertising and other revenue streams;
. 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 offers its search and navigation services; 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.
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 this strategy will be
successful or that we will
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continue to grow and expand the traffic through the network of websites using
our Internet infrastructure services. 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.
A failure to manage and integrate businesses we acquire could divert
management's attention and harm our operations. Acquisitions may also dilute
our existing stockholders
If we are presented with appropriate opportunities, we intend to make
additional acquisitions of, or significant investments in, complementary
companies, products 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. In particular, it may be
difficult to retain key management and technical personnel of the acquired
company during the transition period following an acquisition. Geographic
distances between LookSmart and its acquired businesses may require some
employees to relocate. For these reasons, we may not be successful in
integrating any acquired businesses or technologies and may not achieve
anticipated revenue and cost benefits.
Acquisitions may also result in dilution to our existing stockholders if we
issue additional equity securities and may increase our debt. 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.
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 syndication partners:
. demands on our software and infrastructure systems resulting from
substantial increases in editorial activity or the number of URLs in our
directory;
. customization of the database for syndication;
. substantially increased traffic; 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, syndication and other revenues will decline and our
business will suffer. In addition, as we expand our service offerings and
enter into new business areas such as ecommerce distribution, we may be
required to significantly modify, enhance 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 or hackers, 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 and brand name. In addition, our users
and customers depend on ISPs, online service providers and other website
operators 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.
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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 earthquake, fire, power loss, water damage,
telecommunications failure, hackers, vandalism and similar events. Although
GlobalCenter provides comprehensive facilities management services,
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
for our equipment 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.
We face risks related to expanding into new services and business areas,
including LookSmart Live! and ecommerce distribution
To increase our revenues, we will need to expand our operations by
promoting new or complementary products and services and by expanding into new
business areas. We are continuing to develop and implement various ecommerce
services, including facilitating transactions and providing ecommerce
solutions for small to mid-sized businesses. These products and services 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. These
initiatives may not generate sufficient revenues to offset their cost. In
addition, as we continue to expand our offerings in these and other markets,
we will require significant additional managerial and financial resources that
may strain our existing resources.
For example, one of our new business areas, LookSmart Live!, is capital and
human resource intensive, and may be difficult to scale quickly and
profitably. If we are unable for any reason to expand the service in line with
consumer demand, our reputation and business could suffer. In the fourth
quarter of 1999, the LookSmart Live! service generated no revenues and had
$2.0 million in operating expenses. If we are unable to monetize the traffic
generated from this service, it may not become profitable and may harm our
results of operations and financial condition.
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
the 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 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 business.
We currently face direct competition from companies that provide directory
content, search algorithms, content aggregation and licensing, demographically
and content-targeted advertising, Internet outsourcing and online interactive
service capabilities. As we expand the scope of our Internet services, we will
compete directly with a greater number of Internet search and navigation
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;
18
. 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 to our and our affiliates' websites
A number of significant acquisitions and strategic 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;
. America OnLine's acquisition of Netscape Communications Corporation and
proposed acquisition of Time Warner, Inc.;
. The Walt Disney Company's acquisition of an interest 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;
. @Home Network's acquisition of Excite, Inc.; and
. Ask Jeeves' acquisition of Direct Hit Corporation.
Although the effect of these acquisitions and strategic alliances 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 significantly larger
and have substantially greater marketing and technical resources and name
recognition than LookSmart. As a result, these 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.
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 in many countries abroad, due 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;
. 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;
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. 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, some 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 international advertising and
distribution partners;
. difficulties in recruiting qualified and knowledgeable staff and in
building locally relevant products and services, which could prevent us
from aggregating a large user base;
. unexpected changes and differences in regulatory, tax and legal
requirements applicable to Internet services; and
. foreign currency fluctuations.
Our failure to address these risks could inhibit or preclude our efforts to
expand our business in international markets.
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 and marketing
personnel. In particular, we are currently conducting searches for senior
marketing, international operations and finance 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.
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 to other Internet companies. Many of these
companies have limited operating histories, are operating at a loss and have
limited access to capital. If any significant part of our customer base
experiences financial difficulties or is not commercially successful, our
business will suffer.
Our results will be negatively affected if we fail to adapt to rapid
technological change and evolving industry standards
To be successful, we must adapt to rapidly changing Internet technologies
and evolving industry standards. The introduction of new technologies,
including new or superior Internet search methods, or the emergence of new
industry standards and practices could render our systems and proprietary
software obsolete or require us to make significant unanticipated investments
to adapt to these changes. We must also enhance our existing service offerings
and introduce new products and services to address the changing needs and
demands of Internet users and our customers. If we are unable to respond to
any of these developments on a timely and cost-effective basis, our business
will be adversely affected.
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We may face liability for intellectual property claims or information
contained in our search and navigation services, and these claims may be
costly to resolve
We make information available to end users on our search and navigation
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, 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.
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 obtaining information and engaging in commercial
transactions. Internet usage may decline and ecommerce may be inhibited 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. Any regulations imposed to protect the privacy of
Internet users may affect the way in which we currently collect and use
personal information.
21
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. We cannot assure you that this directive will not
adversely affect our activities, or the activities of BT LookSmart, in
European Union member states.
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
familiar with or technically proficient to customize these settings. 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.
We 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. We could
incur additional expenses if new regulations regarding the use of personal
information are introduced or if any regulator chooses to investigate our
privacy practices.
New tax treatment of companies engaged in Internet commerce may adversely
affect the Internet industry and our company
Tax authorities on 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. 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 December 31, 1999, approximately
26.6 million shares of common stock were held by non-affiliates and
approximately 59.1 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
December 31, 1999, the holders of approximately 42.2 million shares of common
stock and warrants to purchase approximately 13.5 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 exchange their CDIs for shares of
LookSmart common stock. In that event, the exchanged shares of common stock
may be available for resale at the option of the holders in the Nasdaq
National Market. The CDIs currently trading on the Australian Stock Exchange
are exchangeable into an aggregate of approximately 4.4 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.
22
Our stock price is extremely volatile and investors may not be able to resell
their shares for a profit
The stock market has experienced significant price and volume fluctuations,
and the market prices of technology companies, particularly Internet-related
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 which may cause a
decline in the stock price, including:
. changes in the market valuations of Internet companies in general and
comparable companies in particular;
. actual or anticipated quarterly fluctuations in our operating results;
. changes in financial estimates by securities analysts;
. announcements of technological innovations 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.
Government regulation and legal uncertainties could decrease demand for our
services or increase our cost of doing business
Any new law or regulation pertaining to the Internet, or the application or
interpretation of existing laws, could decrease demand for our services, or
increase our cost of doing business, or both. Currently, there are a number of
laws and regulations that pertain to communications or commerce on the
Internet, and it is likely that the number of such laws and regulations will
increase. These laws or regulations may relate to liability for information
transmitted over the Internet, online content regulation, user privacy or the
quality of products or services provided over the Internet. Moreover, the
applicability to the Internet of existing laws governing intellectual property
ownership and infringement, copyright, trademark and trade secret is uncertain
and developing.
Directors, officers and significant stockholders have substantial influence
over LookSmart, which could prevent or delay a change in control
As of December 31, 1999, our executive officers, directors and significant
stockholders and the funds for whom they act as general partner, collectively
owned approximately 69% of the outstanding shares of our 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 certificate of incorporation and approval of
significant corporate transactions, including mergers or sales of all of our
assets. 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
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
23
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 2. PROPERTIES
Our headquarters are located in 137,000 square feet of leased office space
in San Francisco, California. The lease term for our headquarters extends to
October 15, 2009. The lease provides us with an option to renew the lease for
two additional five-year periods after the initial lease term of ten years
expires. In January 2000, we subleased approximately 43,000 square feet of
space at our headquarters facility to third parties. In March 2000, we
subleased an additional 30,000 square feet of space in this facility. These
subleases terminate in December 2000 and the rent received on the subleases is
in excess of our obligation under the original lease.
We also lease approximately 17,000 square feet of space in San Francisco
through November 30, 2000. In January 2000, we subleased all of this space to
a single tenant through the term of the original lease. The rent received on
the sublease is in excess of our obligation under the original lease.
We lease a number of smaller facilities overseas in Melbourne, Sydney,
Montreal, Copenhagen and Amsterdam. These facilities have various lease terms
extending as far as October 2004.
ITEM 3. LEGAL PROCEEDINGS
On October 5, 1998, Hollinger Digital, Inc. filed a complaint against us in
New York Supreme Court (Case No. 604797/98). The complaint alleged that we
breached an agreement to sell 3,059,798 shares of our Series C preferred stock
(representing approximately 15% of our fully vested capitalization at the time
of the alleged breach) to Hollinger for $2.33 per share. The complaint also
asserted claims for promissory and equitable estoppel and sought specific
performance of the proposed terms of the alleged Series C transaction, which
included a right to pro rata participation in future financings prior to our
initial public offering. On December 1, 1998, we filed a motion to dismiss
Hollinger's complaint. On March 17, 1999, the court issued an order granting
our motion and dismissed Hollinger's complaint with prejudice. On May 4, 1999,
Hollinger filed a Notice of Appeal. On November 16, 1999, the Appellate
Division heard oral argument on the matter and took the appeal under
submission. We believe that Hollinger's complaint is without merit and we will
continue to vigorously defend the lawsuit. If we are required to issue shares
of our capital stock in connection with Hollinger's claims, however, our
investors will suffer dilution.
Except for the Hollinger litigation, we are not a party to any material
legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1999.
24
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
LookSmart, Ltd. common stock is quoted on the Nasdaq National Market under
the symbol "LOOK". The following table sets forth the range of high and low
closing sales prices for each period indicated:
HIGH LOW
------- -------
Fiscal 1999:
Third quarter (from August 20)............................ $40.500 $16.250
Fourth quarter............................................ $42.063 $24.375
Fiscal 2000:
First quarter (through March 23).......................... $69.625 $27.500
LookSmart had approximately 7,505 stockholders of record as of December 31,
1999. We have not declared or paid any cash dividends on the common stock and
presently intend to retain our future earnings, if any, to fund the
development and growth of our business and, therefore, do not anticipate
paying any cash dividends in the foreseeable future.
Report of Offering of Securities and Use of Proceeds Therefrom
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
December 31, 1999, 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.
Recent Sales of Unregistered Securities
Since our incorporation in July 1996, we have sold and issued the following
unregistered securities:
(1) On July 24, 1996, we issued 119,640,000 shares of common stock to
two founding stockholders for an aggregate consideration of $19,940.00.
(2) On September 22, 1997, we repurchased 101,640,000 shares of our
common stock from one founding stockholder for the aggregate repurchase
price of $16,940.00 in exchange for the issuance of a warrant to purchase
9,000,000 shares of common stock and a promissory note in the aggregate
amount of $1,500,000. The warrant has an exercise price of $0.00017 per
share.
(3) On January 5, 1998, we issued a warrant for 1,500,000 shares of
mandatorily redeemable convertible preferred stock (Series A) to a bank in
connection with a line of credit agreement for an aggregate purchase price
of $534,400.00.
(4) On February 1, 1998, we issued to one investor a convertible
promissory note in the aggregate amount of $250,000.00, mandatorily
redeemable for preferred stock (Series A).
(5) On February 5, 1998, we issued to two investors convertible
promissory notes in the aggregate amount of $250,000.00, mandatorily
redeemable for preferred stock (Series A).
(6) On March 7, 1998, we issued to one investor a convertible promissory
note in the aggregate amount of $50,000.00, mandatorily redeemable for
preferred stock (Series A).
25
(7) On March 12, 1998, we issued to one investor a convertible
promissory note in the aggregate amount of $75,000.00, mandatorily
redeemable for preferred stock (Series A).
(8) On March 26, 1998, we issued a warrant for 1,010,412 shares of
mandatorily redeemable convertible preferred stock (Series A) to one
investor for an aggregate purchase price of $359,976.12.
(9) On March 27, 1998, we issued to one investor a convertible
promissory note in the aggregate amount of $1,500,000, mandatorily
redeemable for preferred stock (Series A).
(10) On April 6, 1998, we issued to one investor a warrant for 336,804
shares for an aggregate purchase price of $56,134.00 and a convertible
promissory note in the aggregate amount of $500,000.00, both for
mandatorily redeemable convertible preferred stock (Series A).
(11) On May 6, 1998, we issued 1,057,500 shares of common stock to one
director for an aggregate consideration of $8,906.25.
(12) On May 7, 1998, we issued 6,352,614 shares of Series A preferred
stock to seven investors for an aggregate consideration of $2,287,493.39,
we issued 14,327,748 shares of Series B preferred stock to one investor for
an aggregate consideration of $6,004,997.98, and we issued a warrant to
purchase 1,500,000 shares of common stock to one investor for an aggregate
purchase price of $3,750,000.00 and warrants to purchase an aggregate of
3,024,924 shares of Series A preferred stock to two investors for an
aggregate of $1,267,846.48.
(13) On September 10, 1998, we issued a warrant to purchase 480,000
shares of common stock to one investor for an aggregate purchase price of
$200,800.00.
(14) On October 23, 1998, we issued 6,000,000 shares of Series 1 Junior
Preferred to seven investors for an aggregate of $2,900,000.00 in
connection with the acquisition of BeSeen.com, Inc. as a wholly-owned
subsidiary.
(15) On March 24, 1999, we issued 12,007,590 shares of Series C
preferred stock to 45 investors for an aggregate of $60,037,950.00, and a
warrant to purchase 439,999 shares of Series C preferred stock to one
investor for an aggregate purchase price of $2,199,997.50. On April 26,
1999, we issued 75,939 shares of Series C preferred stock to 14 investors
for an aggregate of $379,695.00.
(16) On April 9, 1999, we issued 2,550,000 shares of common stock to one
investor for the aggregate consideration of $6,375,000.00 in connection
with an asset purchase.
(17) On June 9, 1999, we issued warrants to purchase an aggregate of
540,000 shares of common stock to four investors for an aggregate
consideration of $675,000 in connection with an asset purchase.
(18) On December 30, 1999, we committed to issue up to 71,870 shares of
common stock to four investors in connection with a purchase of securities
in Futurecorp International Pty Ltd.
(19) Since our incorporation, we have issued options to purchase an
aggregate of 25,693,000 shares of common stock with exercise prices ranging
from $0.00953 to $34.6250 per share. Since our incorporation, options to
purchase 3,019 shares of common stock have been exercised for an aggregate
consideration of $187,000.
(20) Since our incorporation, we have issued warrants to purchase an
aggregate of 17,832,140 shares of preferred and common stock with exercise
prices ranging from $0.00017 to $7.50 per share. Since our incorporation,
warrants to purchase 14,423,048 shares of preferred and common stock have
been exercised for an aggregate consideration of $2,522,000.
There were no underwriters employed in connection with any of the foregoing
transactions.
The issuances of securities described in (1), (4), (5), (7), (9), (12),
(15) and (18) were deemed to be exempt from registration under the Securities
Act in reliance on Section 4(2) and on Regulation S of the Securities Act as
26
transactions by an issuer not involving a public offering and the offer and
sale of securities to non-U.S. investors. The issuance of securities described
in (2), (3), (6), (10), (11), (13), (16) and (17) were deemed to be exempt
from registration under the Securities Act in reliance on Section 4(2) of the
Securities Act as transactions by an issuer not involving a public offering.
The issuance of securities described in (14) and (15) were deemed to be exempt
from registration in reliance on Sections (2) and 4(6) of the Securities Act.
The issuances of securities described in (19) and (20) were deemed to be
exempt from registration under the Securities Act in reliance on Section 4(2)
or Rule 701 promulgated thereunder as transactions pursuant to compensatory
benefit plans and contracts relating to compensation. The recipients of
securities in each such transaction represented their intention to acquire the
securities for investment only and not with a view to or for sale in
connection with any distribution thereof and appropriate legends were affixed
to the share certificates and other instruments issued in such transactions.
All recipients either received adequate information about the Registrant or
had access, through employment or other relationships, to such information.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and Notes to those
statements and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere in this report.
Period from
July 19, 1996 Year Ended
(Inception) to --------------------------------------
December 31, December 31, December 31, December 31,
1996 1997 1998 1999
--------------- ------------ ------------ ------------
(in thousands except per share amounts)
Statements of Operations
Data:
Net revenues.......... $ 3 $ 949 $ 8,785 $ 48,865
Gross profit.......... (87) 519 7,199 41,947
Total operating
expenses............. 2,739 7,848 19,097 109,065
Net income (loss)..... (2,900) (7,514) (12,858) (64,663)
Net income (loss) per
share--basic and
diluted.............. $ (0.03) (0.08) $ (0.68) $ (1.42)
Shares used in per
share calculation--
basic and diluted.... 115,947 91,589 18,790 45,518
December 31, December 31, December 31, December 31,
1996 1997 1998 1999
------------ ------------ ------------ ------------
Balance Sheet Data:
Working capital
(deficit)............... $ (429) $(1,125) $(6,507) $ 82,688
Total assets............. 2,825 2,275 14,090 161,519
Long-term debt and
capital lease
obligations, net of
current portion......... -- 1,500 1,500 1,423
Total stockholders'
equity (deficit)........ $2,091 $ (453) $(1,261) $119,552
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements and the notes to those statements which
appear elsewhere in this Form 10-K. 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, the adequacy of our capital
reserves and our future need for additional capital. 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 report,
particularly in "Business-- Risk Factors".
27
Overview
LookSmart was formed in July 1996 as a Delaware corporation under the name
of NetGet Ltd. to acquire the business and associated intellectual property of
HomeBase Directories Pty Ltd., an Australian company founded by Evan Thornley
and Tracey Ellery in October 1995. At that time, The Reader's Digest
Association purchased approximately 85% of our outstanding common stock, an
investment it held until October 1997 when it exchanged this stock for
warrants to purchase 9 million shares of our common stock and a $1.5 million
promissory note. We changed our name to LookSmart, Ltd. in October 1996. In
July 1997, we relocated our headquarters from Australia to San Francisco,
California.
Prior to July 1997, revenues from our business were incidental and we were
primarily focused on investing in editorial resources and building our
Internet directory. Until October 1997, our cash requirements were satisfied
primarily by funds provided by The Reader's Digest Association and, to a
lesser extent, from advertising revenues from sales made through outside sales
forces. Our advertising revenues continued to increase during the fourth
quarter of 1997 and the first quarter of 1998.
During 1998, we entered into several key operational relationships designed
to increase traffic to our website and to expand our directory. In May 1998,
we raised a total of approximately $8.3 million in our Series A and Series B
preferred stock financings, marking the beginning of our strategic
relationship with Cox Interactive Media to develop web directories for key
local United States markets. This infusion of capital allowed us to
significantly increase the resources devoted to editorial and product
development, establish our own advertising sales force and significantly
strengthen our management team.
In May 1998, we entered into a one-year traffic contract with Netscape,
which has been renewed through July 2000. Under this arrangement, Netscape
periodically directs user search traffic to LookSmart for a fixed cost per
thousand impressions.
In October 1998, we acquired BeSeen.com, Inc., a leading provider of tools
to webmasters, for 6 million shares of our Series 1 Junior preferred stock.
The primary purpose of this transaction was to generate traffic and website
relationships for LookSmart to increase advertising sales.
In December 1998, we entered into a five-year contract with Microsoft.
Under this agreement, we license our database to Microsoft, and we are
obligated to increase the number of unique URLs included in our database every
six months by pre-defined amounts. Microsoft has the right to determine the
criteria for a portion of these URLs. Microsoft paid us an initial non-
refundable license fee and committed to a fixed schedule of additional
payments for updates. A portion of each update payment is subject to refund if
we fail to provide the contractually required number of URLs. The difference
between any cash received under the contract and revenues recognized to date
is recorded as deferred revenues. At December 31, 1999, deferred revenue
associated with the Microsoft contract was $18.5 million. After June 5, 2000,
either party may terminate the agreement for any reason on six months' notice
The terms of our agreement with Microsoft could cause our quarterly
licensing revenues and operating results to fluctuate significantly. We
recognize quarterly revenues under this agreement 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
contractual measurement period. As a result, to the extent that we satisfy our
database update obligations unevenly, the revenues we recognize may be skewed
on a quarter-to-quarter basis. Because the six-month contractual measurement
periods end on June 5 and December 5 of each year, our second and fourth
quarters may include revenues from more than one six-month contractual
measurement period. This may result in additional quarter-to-quarter
fluctuations in revenues.
In March 1999, we raised approximately $60.3 million in our Series C
preferred stock round of financing. The proceeds from this financing were used
to increase working capital, to fund operating losses and to enter into
strategic relationships and acquisitions.
28
In April 1999, we acquired certain lines of business and other rights from
Guthy-Renker Internet, LLC as part of a strategic alliance between our two
companies for $5.0 million in cash and 2.55 million shares of LookSmart common
stock. We also earn revenues from Guthy-Renker Corporation's "As Seen on TV"
products that are sold online and promoted through television infomercials. We
are entitled to place LookSmart advertising on Guthy-Renker Corporation
infomercials.
On June 9, 1999, we acquired substantially all of the assets of ITW
NewCorp, Inc., in exchange for $5.0 million in cash and warrants to purchase
420,000 shares of LookSmart common stock. Through this asset purchase, we
provide Internet bulletin board services which generate advertising revenue.
In June 1999, we entered into five agreements with three PBS-related
entities under which we agreed to sponsor five programs on PBS. The agreements
vary in duration from three to five years. At December 31, 1999, LookSmart was
committed to pay a total of $13.3 million for the remainder of the contract
periods if all five agreements remain effective throughout their terms. These
payments will be recorded as sales and marketing expense, and generally will
be spread equally over the terms of the contracts. The PBS-related entities,
in return, have agreed to promote LookSmart on their respective websites.
Specifically, the arrangement provides that LookSmart's website is provided a
direct link to the PBS website www.pbs.org. The agreements do not guarantee
LookSmart a minimum number of impressions.
In June 1999, we entered a three-year licensing agreement with Excite@Home.
Under this agreement, we license our database to Excite@Home.
On August 19, 1999, LookSmart completed its initial public offering of
8,855,000 shares of common stock, including 1,155,000 shares issued in
connection with the exercise of the underwriters' over-allotment option. All
shares were issued at an offering price of $12.00 per share. Net proceeds from
the offering after underwriting discounts and commissions and offering
expenses of $9.3 million were approximately $96.9 million.
In November 1999, we entered into an agreement with Inktomi Corp. to co-
bundle our search technologies for offerings to vertical portals. As of
December 31, 1999, we had not recognized any revenue related to this
agreement.
In December 1999, we acquired 14.5% of the outstanding voting stock of
Dstore Pty Ltd, an Australian privately held company, for $328,000. This
transaction was accounted for as an investment using the cost method of
accounting. Dstore is an online department store offering a variety of
products for sale over the Internet.
In December 1999, we acquired stock which controls 52% of the outstanding
voting rights of Futurecorp International Pty Ltd., an Australian privately
held company, for $1,840,000 cash and the committed issuance of 71,870 shares
of common stock. This transaction was accounted for as a purchase.
Futurecorp's results of operations subsequent to the transaction have been
consolidated as of December 31, 1999. Through the acquired business, we
provide web-based communication applications and community building solutions
focused primarily in Australia.
Revenues and Cost of Revenues
Advertising and Syndication. LookSmart provides a high quality environment
for advertisers to promote their products and services. We generally provide
advertisers with one to three month agreements to serve a minimum number of
banner impressions over the term of the agreement. In several cases, we have
entered into longer agreements. We offer advertisers the ability to specify
the category of traffic for their banner advertisements, and we are able to
charge premiums on some categories based on advertisers' perceptions of
economic value, including the placement of the advertisement on the page, the
demographics of the users who view the page, and the size of the audience
requesting the page.
We expect advertising revenues to continue to account for a significant
portion of our revenues for the foreseeable future. Our ability to maintain
current levels of advertising revenues will depend on our ability to re-
29
sign or replace existing advertisers as their contracts expire. We expect
downward pressure on advertising prices in the industry generally due to the
increasing amount of advertising inventory coming onto the Internet from other
sources. Therefore, we expect that any future increases in advertising
revenues will depend on our ability to effectively manage our advertising
inventory by leveraging our targeted category-based model to charge premium
rates, and on our ability to grow the inventory availability by increasing
traffic to Internet properties using our search solutions.
In our limited operating history, we have experienced seasonality in
advertising revenues with typically weaker demand from advertisers in the
first and third calendar quarters. We expect that advertising revenues will
continue to be subject to seasonality. In particular, the rate of growth, if
any, between the last quarter of one year and the first quarter of the next
year tends to be less than the rate of growth experienced between other
consecutive quarters. This is due in part to the fact that the fourth quarter
contains increased advertising spending in anticipation of the holiday season.
Because advertising revenues represent a significant portion of our
business, fluctuations in advertising revenues due to pricing pressures, the
timing or cancellation of contracts, inventory management, seasonality, site
down time or other factors can be expected to have a significant effect on our
overall operating advertising revenues. However, our costs are fixed, at least
in the short term, and cannot be expected to track fluctuations in advertising
revenues. To the extent that costs do not track changes in advertising
revenues, fluctuations from this revenues source will have a
disproportionately large impact on net income or loss.
We generate revenues from syndication agreements by sharing with our
syndication partners advertising sales revenue associated with traffic
referred between the partners and LookSmart. In some cases, our syndication
partner receives gross revenues from the advertiser and then makes a payment
to LookSmart for our share of those revenues. In other cases, we receive the
gross revenues from the advertiser, and then forward a portion of these
revenues to the syndication partner. We work with our ISP partners to "co-
brand", or create partner-specific home pages which have the "look and feel" a
partner desires and which provides the ISP subscriber fully-functional access
to the LookSmart database. In these cases, LookSmart derives the advertising
sales revenues from the traffic generated by the ISP partner and compensates
the partner, typically on a per impression or per referral basis, for this
traffic.
The principal components of cost of advertising and syndication revenues
are personnel costs of our in-house advertising operations employees,
equipment depreciation, other expenses relating to hosting advertising
operations and agency commissions paid to outside advertising sales
organizations.
Licensing. We license our database content to some of our partners,
including Microsoft and Excite@Home. We expect revenues from licensing to
fluctuate from period to period because these revenues are dependent upon the
particular terms of our licensing arrangements and the expiration, renewal and
addition of agreements with current and future partners. We do not anticipate
recurring cost of licensing revenues in connection with our licensing
activities; the cost of developing URL databases is included in product
development. Revenues associated with licensing contracts are recognized as
delivery occurs as specified under the contracts, and where no refund
obligations exist.
Ecommerce/Distribution. The scale and quality of our alliances provide an
effective distribution network to marketers of products and services. We
enable users searching for products and services in our database to find
ecommerce vendors seeking a channel to reach relevant business and consumers.
We offer ecommerce solutions to marketers of products and services, providing
them with significant opportunities to reach the highly targeted audience of
Internet users accessing our search solutions. These solutions may include
carriage or listing services, referral or lead generation services and product
distribution services.
The Company's ecommerce/distribution revenue is generated by the sale of
merchandise and the design, construction and hosting of commercial websites.
Revenue from the sale of merchandise is reported on a gross basis if the
Company acts as the principal in the transaction with associated product cost
reported as cost of
30
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.
The principal components of cost of ecommerce and distribution revenues are
product costs paid in connection with our "As Seen on TV" merchandise sales,
fulfillment costs and direct costs associated with site hosting. These costs
will fluctuate with the level of these activities.
Operating Expenses
We do not track operating expenses by reportable segment, but treat these
as shared overhead of our three reportable segments.
Sales and Marketing. Sales and marketing expenses include payments to
syndication partners who are portals, ISP partners and other traffic providers
for directing online users to the LookSmart database. Traffic payments can
exhibit significant fluctuations from period to period depending on the
contracts in effect, volume of traffic going to the partner sites and the
contracted rates. Further, traffic payments as a percentage of revenues can
vary significantly depending on the structure of the payment arrangements
between us and our affiliates. When a traffic arrangement is structured so
that we receive only the portion of the gross advertising revenues forwarded
to us then little or no sales and marketing expense is directly associated
with that revenue stream. On the other hand, when a traffic arrangement is
structured so that we collect the gross advertising revenues and forward a
portion to our affiliate, we record as revenues the entire amount of the gross
advertising revenues, and the portion forwarded to the partner is recorded as
sales and marketing expense. We expect payments to our affiliate and
distribution partners to increase as we expand our business.
From April 1999 through October 1999, our sales and marketing expenses
included the cost of website development seminars which focused on selling web
pages and offering related services. Sales and marketing expenses also include
the costs of advertising, trade shows and public relations activities. Due to
the one-time nature of these expenditures, sales and marketing expenses will
be subject to significant fluctuations from period to period. Sales and
marketing costs also include salaries and associated costs of employment
overhead and facilities. Sales and marketing costs are expensed as incurred.
Product Development. Product development costs, including research and
development costs, have been expensed as incurred except to the extent that
costs for internal use software are required to be capitalized and amortized
under American Institute of Certified Public Accountants Statement of Position
98-1 (SOP 98-1). During 1999 we capitalized $443,000 of internal use software
costs and we are amortizing these costs over two years. Amortization relating
to internal use software was $84,000 in 1999. Product development expenses
include the editorial development costs of building our content database and
engineering costs of maintaining and improving the development environment,
including our proprietary Editorial Support System software. These costs
include salaries and associated costs of employment, overhead and facilities.
Software licensing and computer equipment depreciation related to supporting
product development functions are also included in product development
expenses. These costs are relatively fixed in the short term.
We expect product development costs to continue to increase as we increase
the size and reach of our distribution network and offer new products and
services to our partners, both domestically and overseas.
General and Administrative. General and administrative expenses include
overhead costs such as executive management, human reso