Back to GetFilings.com
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 000-26357
----------------
LOOKSMART, LTD.
(Exact name of Registrant as specified in its charter)
Delaware 7373 13-3904355
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or Identification No.) Identification No.)
organization)
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)
----------------
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
----------------
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 1, 2001,
was approximately $105,646,810.07. 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 1, 2001, 91,717,869 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, 2000.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
TABLE OF CONTENTS
PART I
Page
----
ITEM 1. BUSINESS...................................................... 3
ITEM 2. PROPERTIES.................................................... 23
ITEM 3. LEGAL PROCEEDINGS............................................. 23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 23
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.......................................... 24
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.......................... 26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................... 27
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.... 38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................... 39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL
DISCLOSURE................................................... 62
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............ 63
ITEM 11. EXECUTIVE COMPENSATION........................................ 63
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................... 63
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................ 63
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K..................................................... 63
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.
LookSmart creates highly targeted online marketing products for its customers
by matching the users' need for relevant search results with the online
marketer's need for effective targeting. LookSmart creates a range of
directory listings and search targeted advertising products that are
distributed through its search infrastructure platform through leading
Internet portals, ISPs and media companies. By enabling online marketers to
reach millions of users in a highly targeted search context, LookSmart helps
its customers to maximize the conversion of advertising into sales and thereby
provides its customers with an effective complement to or substitution for
their other online and offline methods of acquiring customers.
Our domestic network of search partners and affiliates includes:
. Internet portals such as Microsoft's MSN, Excite@Home and AltaVista;
. media companies such as AOL Time Warner, Sony, Cox Interactive Media and
MacroMedia/Shockwave;
. Internet services providers, or ISPs, such as Juno, Prodigy, Qwest and
RoadRunner; and
. thousands of 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, except
for China and Australia. 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.
Our search solutions consist of a robust suite of search products. At the
core of our search solutions are high-quality directories and search-specific
content. Through the use of technology and human editors, we have assembled
what we believe to be one of the largest directories of high-quality, and
search-specific content on the Internet. Our directories have approximately
2.6 million links to, and reviews of, high-quality websites organized into
approximately 250,000 categories. We exclude hate and pornographic web sites
from our directory. Internet users can search our directories by browsing
through categories and subcategories or by searching by keyword.
Industry Background
The emergence and wide acceptance of the Internet has fundamentally changed
how millions of people and businesses worldwide find information, communicate
and purchase goods and services. We believe that the number of Internet users
worldwide, and the number of unique web pages in existence worldwide, will
continue to increase at a rapid rate. 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, the digitization of information and improvements in network
infrastructure. These factors make the Internet accessible to inexperienced
users
3
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.
The Search Challenge
The massive volume and growth of 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 highly
specialized and local content.
The Search Infrastructure Challenge
We believe that the ability to search is critical to most Internet users'
ability to use 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.
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
websites through online advertising, they need to find a means of both
attracting a large volume of traffic to 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 traditional 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 an overhead investment 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.
4
The LookSmart Solution
Our search solutions enable our partners and affiliates to achieve their
objectives of providing a superior user experience and maximizing the revenues
from their website traffic. We have assembled what we believe to be one of the
largest directories of high-quality 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. 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. In the process, we seek to address the challenges faced
by users, content providers, advertisers and vendors.
Our Search Solution
We provide web directories that enable users to find useful information
quickly. Our services allow users to choose between browsing the directory
through an intuitive category search path and entering keywords in a search
box.
Comprehensive Content. Our directories currently contain approximately 2.6
million unique URLs in 250,000 categories. We have developed locally relevant
and culturally sensitive Internet directories for Canada, Australia, Brazil,
Mexico and other countries in the western hemisphere, as well as over 70 local
areas in the United States. We have also developed narrowband directories for
19 countries and wireless directories for 17 countries in Europe and Asia,
which we have licensed to BT LookSmart, our joint venture with British
Telecommunications. BT LookSmart offers these and other directory services for
countries in Europe and Asia, aside from China and Australia.
High-Quality Content. We focus on including only authoritative, up-to-date,
categorized content in our directories. Our team of approximately 250 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 directories.
Easy-to-Navigate Content. LookSmart's directories are 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 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.
Our Search Infrastructure Solution
Our ability to categorize and organize highly specific content from the
Internet and to 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 technology 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 the value
proposition of our solutions. We work with our partners to customize our
directories to meet the particular needs of their website strategy and core
audience.
Our search infrastructure solutions offer three principal benefits to our
partners. First, we provide our partners with customized, private label search
functionality, thereby enabling them to save the resources and expertise that
would be necessary 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.
5
Our Advertising Solution
We launched www.looksmart.com, the showcase site for our LookSmart
directory database, in October 1996. We leverage our database by licensing and
distributing our search solutions to leading Internet portals, ISPs, media
companies and other websites, including AltaVista, AOL Time Warner, CNN, Cox
Interactive Media, Excite@Home, InfoSpace, Inktomi, iWon, Juno, Microsoft's
MSN, Netscape Netcenter, Prodigy, Road Runner and Qwest. As a result of our
substantial Internet user base, we are able to offer advertisers the
opportunity to reach Internet users on a broad scale.
In addition, we offer both traditional, targeted graphical advertising
products and new paid listings products. The listings products allow
advertisers to have their URL links appear as search results on many of
LookSmart's Internet portal and ISP partners' search results. We believe that
our listings products are effective both in terms of user click-through and
conversions to sale, resulting in lower customer acquisition costs for
advertisers.
The LookSmart Directories
LookSmart has 32 directories for 27 countries around the world, including
those which are licensed to BT LookSmart for distribution in Europe and Asia.
In addition, we have 24 wireless directories for 19 countries around the
world. Through an arrangement with Genie, an affiliate of British
Telecommunications, the wireless directories are offered to British
Telecommunications' wireless customers in Europe and Asia.
Our editorial teams, located in Amsterdam, Berlin, Copenhagen, London,
Melbourne, Montreal, Paris, Tokyo and San Francisco, use proprietary and
licensed software that enables them to find, review, describe and categorize
websites and to check whether websites are 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. In October
2000, we completed the acquisition of Zeal Media, Inc., a community-based web
directory provider. Once the integration of Zeal Media's technology and
systems is completed, the acquisition will provide LookSmart with an
additional means of finding relevant content.
Select the Content
In finding content, our editors encounter 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 related to cosmetic surgery, pornographic material, or
material from sources with limited medical authority. Our editors select and
place content for each of approximately 250,000 categories according to
standards that our taxonomy team maintains. Also, the editors 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 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 search service is a list
of website links. Our editors facilitate the search process by providing
succinct descriptions of approximately 20 words for every listed website to
assist users in determining which websites contain content most relevant to
their search.
6
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.
LookSmart Products and Services
Listings
In 2000, listings revenues were $10.3 million, or 9.1%, of our total
revenues. Our listings revenues derive from two products: Express Listings and
Subsite Listings. Express Listings, launched in the first quarter of 2000,
involve a one-time fee paid by owners of websites for the expedited review of
their website and, if the website meets LookSmart's editorial guidelines,
inclusion of the website in the appropriate categories in LookSmart's
directories. As of December 31, 2000, LookSmart's directories included over
22,000 individual listings which were submitted by Express Listings customers.
Subsite Listings, launched in the third quarter of 2000, involve the
payment by website owners of a one-time review fee and periodic cost-per-click
and maintenance payments for the inclusion of subsites in the appropriate
categories in LookSmart's directories. As of December 31, 2000, LookSmart's
directories included over 24,000 individual listings for subsite customers,
including Amazon.com, CNET's mySimon, DealTime, eBay and VerticalNet.
Listings revenues also include revenues derived from our affiliate program,
under which we receive payments for the referral of traffic to affiliate
vendors.
Advertising/Syndication
In 2000, advertising/syndication revenues were $64.7 million, or 57.4%, of
our total revenues. In connection with providing search functionality to our
partners, we often place, sell and serve the advertising on our partners'
search results pages. In many 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 three factors drive advertising business to
LookSmart:
. we deliver highly targeted advertising based on the specific content 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 approximately 41 people located in San Francisco, New
York, Los Angeles and Detroit.
Some of the businesses that advertised on our website or the websites of
our distribution affiliates recently include: Amazon.com, AutoWeb, BizRate,
DealTime, eBay, Gateway, General Motors, LowestFare, Microsoft, SBC, Staples,
VerticalNet and Wells Fargo.
7
Licensing
In 2000, licensing revenues were $19.6 million, or 17.4%, of our total
revenues. We receive revenue from licensing and customizing our directories
based on the specifications and needs of our customers. Our licensing
customers include Microsoft and Excite@Home. In addition, we have built 27
country-specific databases and established partnerships abroad, such as our
partnership with British Telecommunications to form BT LookSmart, an equally-
owned joint venture which provides search and directory services in Europe and
Asia.
Ecommerce
In 2000, ecommerce revenues were $18.1 million, or 16.0%, of our total
revenues. 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. In 2000, substantially all of our
ecommerce revenues were derived from sales of Guthy-Renker products. Under our
agreement with Guthy-Renker, our exclusive right to the online sales of Guthy-
Renker products expires in April 2002.
International Operations
LookSmart seeks to expand its business operations in countries where use of
the Internet as a commercial medium has grown sufficiently to support our
business model. We believe that as the Internet continues to be adopted as a
primary means of communication and commerce, worldwide demand will continue to
grow for web directories. Central to our international efforts is our ability
to tailor our directories for individual markets in order to create a more
locally relevant, culturally sensitive offering. We currently have editorial
teams located in Amsterdam, Berlin, Copenhagen, London, Melbourne, Montreal,
Paris, Tokyo and San Francisco.
BT LookSmart, our joint venture with British Telecommunications, maintains
local country-specific directories and provides search solutions for selected
countries in Europe and Asia. BT LookSmart provides web directories in a
number of countries across Europe and Asia. In 2000, BT LookSmart's total
revenues were $3.2 million and it had a net loss of $21.9 million.
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:
AltaVista
In July 2000, we entered into a two-year agreement with AltaVista Company,
under which we provide our directory and related services to AltaVista for use
by AltaVista on its portal services.
BT LookSmart
In February 2000, LookSmart and British Telecommunications established a
joint venture, BT LookSmart, which offers web directories for selected
countries in Europe and Asia. BT LookSmart offers web and wireless directories
for 18 countries, including the United Kingdom, France, Germany, 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
wireline and wireless 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
8
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.
Inktomi
In November 1999, we entered into an agreement with Inktomi Corp. to co-
bundle our search technologies for offerings to portals. In December 2000, we
amended the agreement to provide for the inclusion of the LookSmart directory
in Inktomi's search index and to provide for sharing of revenues derived from
Inktomi's distribution of Subsite Listings.
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 at any time on six months' notice. Under the
agreement, we provide Microsoft with custom-tailored Internet directory
content according to Microsoft's requests in six-month increments.
Netscape
In June 2000, we renewed our agreement with Netscape Communications
Corporation for one year. Under this agreement, Netscape directs user search
traffic to LookSmart for a fixed cost per thousand referrals.
Prodigy
In July 2000, we entered into a three-year agreement with Prodigy
Communications Corporation, which was subsequently acquired by SBC
Communications, Inc. Under this arrangement, Prodigy directs user search
traffic to LookSmart for a fixed cost per thousand impressions.
Time Warner
In January 2000, we entered into an agreement with Time Warner, Inc., which
was subsequently acquired by America Online, Inc. Under the agreement, we
syndicate our search service across Time Warner's 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 targetability of our advertising, the performance of our
marketing services and the quality of our directory content. In the licensing
and syndication market, there are additional factors such as 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.
9
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 retrieval Internet search, content AOL Time Warner, Yahoo!,
aggregation and content licensing Netscape Open Directory,
Inktomi, Google, Ask
Jeeves, AltaVista, Terra
Lycos, NBCi, GoTo.com
Internet advertising and Demographically targeted and Internet advertising
marketing content-targeted advertising networks like
DoubleClick and 24/7
Media; Internet
navigation firms with
similar content
targeting capabilities
like AOL Time Warner,
Yahoo!, and Terra Lycos
Search solution outsourcing Outsourcers of Internet search Inktomi, Google,
solutions, Internet portal or website Netscape Open Directory,
enhancement content Ask Jeeves, GoTo.com
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 dead link checking.
The Editorial Support System also provides various statistical and
reporting functions, including editorial productivity levels, and identifies
trends in user preferences. The system includes capabilities for some 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 approximately 250,000 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.
10
Exodus and Savvis
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 has
since been acquired by Exodus Communications, Inc. Exodus provides
comprehensive facilities management services, including human and technical
monitoring of all production servers, 24 hours per day, seven days per week.
In December 2000, we entered into an agreement with Savvis Communications,
Inc. to house additional networking and web serving hardware.
Marketing
Marketing activities are 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;
. 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 approximately 690 employees as of December 31, 2000. However, in
January 2001, we implemented a restructuring plan that resulted in staff
reductions of 172 employees. We have never had a work stoppage, and none of
our United States employees is represented by a labor union. We consider our
relations with our employees to be good.
11
RISK FACTORS
You should carefully consider the risks described below before making a
decision to invest in our stock. If any of the following risks actually
occurs, 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 part or all 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 in 1998, $64.7 million in 1999 and $62.6 million
in 2000. As of December 31, 2000, we had an accumulated deficit of
approximately $150.5 million. We expect to have net losses and negative cash
flow for the foreseeable future. The size of these net losses will depend, in
part, on our ability to grow our revenues, capitalize on new sources of
revenue and contain our expenses. We expect to spend significant amounts to:
. maintain and expand our network of distribution partners;
. develop our international business, particularly through our BT
LookSmart joint venture with British Telecommunications;
. continue to develop and expand directories of Internet listings, both in
the U.S. and abroad;
. develop new products and enhance the functionality of our search and
directory listings services; and
. acquire complementary technologies and businesses.
We recently announced steps to narrow our losses, including management
restructuring and a reduction in staff. Although these steps are intended to
reduce our quarterly operating expenses in the future, we cannot guarantee
that these steps will achieve the expected reduction in operating expenses.
Because our operating expenses are likely to continue to exceed our revenues
in the near term, we will need to generate significant additional revenues to
achieve operating profitability. Even if we do achieve operating
profitability, we may not be able to maintain or increase our operating
profitability on a quarterly or annual basis.
Our quarterly revenues and operating results may fluctuate, each of which may
negatively affect our stock price
Our quarterly revenues may fluctuate significantly as a result of a variety
of factors that could affect our operating results in any particular quarter.
These factors include:
. the level of user traffic on our and our distribution partners' websites
and our ability to derive revenue from that traffic in any given
quarter;
. the demand for our Internet search services;
. the demand for Internet advertising and changes in the advertising rates
we charge;
. the timing of revenue recognition under our listings, licensing and
advertising contracts;
. the timing of our entry into and magnitude of new contracts for
advertising, licensing and syndication;
. seasonality of our advertising and e-commerce 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
12
. the timing of our delivery of URLs under our contract with Microsoft. We
recognize quarterly revenues under this contract based on the number of
URLs added to our database during the quarter relative to the total
number of URLs we are required to add to our database during the
relevant six-month period. As a result, to the extent that we satisfy
our database update obligations unevenly, the revenues we recognize
under this contract may be skewed on a quarter-to-quarter basis.
Our expense levels are based in part on expectations of future revenues
and, to a large extent, are fixed. We may be unable to adjust spending quickly
enough to compensate for any unexpected revenue shortfall. Our operating
results may vary as a result of changes in our expenses and costs.
Due to the above factors, we believe that period-to-period comparisons of
our operating results are not necessarily meaningful, and you should not rely
on them as indicators of our future performance. If our operating results in
any future period fall below the expectations of securities analysts and
investors, the market price of our securities would likely decline.
We may need additional capital in the future to support our growth and
additional financing may not be available to us
Although we believe that our working capital will provide adequate
liquidity to fund our operations and meet our other cash requirements until at
least the end of 2001, unanticipated developments in the short term, such as
the entry into agreements which require large cash payments, further
deterioration of the online advertising market or the acquisition of
businesses with negative cash flows, may necessitate additional financing. In
any case, we may seek to raise additional funds through public or private debt
or equity financings in order to:
. fund our operations and capital expenditures;
. take advantage of favorable business opportunities, including geographic
expansion or acquisitions of complementary businesses or technologies;
. develop and upgrade our technology infrastructure;
. reduce outstanding debt;
. develop new product and service offerings;
. take advantage of favorable conditions in capital markets; or
. respond to competitive pressures.
The capital markets, and in particular the public equity market for
Internet companies, have traditionally been volatile. It is difficult to
predict when, if at all, it will be possible for Internet companies to raise
capital through these markets. We cannot assure you that the additional
financing will be available on terms favorable to us, or at all.
Our business prospects depend on the continued growth of Internet advertising
and our ability to generate advertising revenues
For the year ended December 31, 2000, advertising/syndication revenues
accounted for 57.4% of our total revenues, as compared to 45.2% of our total
revenues in the year ended December 31, 1999. We expect that revenues from
advertising/syndication will continue to represent a significant portion of
our total revenues for the foreseeable future. Our advertising/syndication
revenues decreased in the fourth quarter of 2000 and may continue to decrease
due to weakness in the online advertising market, reductions in online
advertising expenditures by Internet companies and downward pressure on
advertising rates industry-wide.
13
We compete with traditional media such as television, radio and print, as
well as online advertisers and high-traffic websites, for a share of
advertisers' total advertising expenditures. We have experienced, and may
continue to experience, downward pressure on advertising prices in the
industry due to the increasing amount of advertising inventory becoming
available on the Internet. As the Internet evolves, advertisers may find
Internet advertising to be a less effective means of promoting their products
or services relative to traditional advertising media and may reduce or
eliminate their expenditures on Internet advertising. Many potential
advertisers and advertising agencies have only limited experience advertising
on the Internet and have not devoted a significant portion of their
advertising expenditures to Internet advertising. Acceptance of the Internet
among advertisers will depend, to a large extent, on the perceived
effectiveness of Internet advertising and the continued growth of commercial
usage of the Internet.
Currently, there are a variety of pricing models for selling advertising on
the Internet, including models based on the number of impressions delivered,
the number of click-throughs by users, the duration over which the
advertisement is displayed or the number of keywords to which the
advertisement is linked. It is difficult to predict which pricing model, if
any, will emerge as the industry standard. This uncertainty makes it difficult
to project our future advertising rates and revenues that we may generate from
advertising. In some cases, we share advertising revenue with our network
partners based on the number of users directed to advertisements or third
party web sites. A decrease in advertising sold or advertising rates or an
increase in revenue sharing obligations could adversely affect our operating
results. In addition, our ability to earn advertising revenues depends on the
number of advertising impressions per search and the number of click-throughs.
In addition, our advertising revenues will depend on our ability to
achieve, measure and demonstrate to advertisers the breadth of the traffic
base using our search service and the value of our targeted advertising.
Filter software programs that limit or prevent advertising from being
displayed on a user's computer are available. It is unclear whether this type
of software will become widely accepted, but if it does, it would negatively
affect Internet-based advertising.
We derive a significant amount of our revenues from Microsoft, and if
Microsoft terminates its contract with us, our business could be harmed
We derive a significant amount of our revenues under an agreement with
Microsoft Corporation, and either party may terminate the agreement for any
reason on six months' notice. For the year ended December 31, 2000, revenues
from Microsoft under this agreement accounted for $17.2 million or 15% of our
total revenues. The cash payments we receive for each six-month period under
this agreement are subject to full or partial refund if we fail to provide the
stated number of URLs during that period. After the agreement is terminated,
Microsoft has the right to continue to use the content we delivered during the
term of the agreement. Microsoft also has the right to sublicense these rights
to others, both during and for up to two years after the term of the
agreement.
Our revenues and income potential are unproven and our business model is
continuing to evolve
We were formed in July 1996 and launched our Internet directory in October
1996. Because of our limited operating history, it is extremely difficult to
evaluate our business and prospects. You should evaluate our business in light
of the risks, uncertainties, expenses, delays and difficulties associated with
managing and growing a relatively new business, many of which are beyond our
control. In addition, we compete in the relatively new and rapidly evolving
Internet search infrastructure market, which presents many uncertainties that
could require us to further refine or change our business model. Our success
will depend on many factors, including our ability to:
. profitably establish and expand our new product offerings, particularly
Express Listings and Subsite Listings;
. expand and maintain our network of distribution relationships, thereby
increasing the amount of traffic using our web directory; and
. attract and retain a large number of advertisers from a variety of
industries.
14
Our failure to succeed in one or more of these areas may harm our business,
results of operations and financial condition.
BT LookSmart will require a substantial investment of resources and may not
ever become profitable
Our success will depend in part upon the success of BT LookSmart, our joint
venture with British Telecommunications. We face many risks associated with BT
LookSmart, such as:
. we will recognize 50% of the net loss from the joint venture as non-
operating expense on our statement of operations. For the year ended
December 31, 2000, our share of the joint venture's revenues were $3.2
million and a net loss of $21.9 million. We expect the venture to incur
significant losses and require large capital expenditures for the
foreseeable future. We cannot project when BT LookSmart will generate
cash for us or become profitable, if at all;
. we were initially obligated under the joint venture documents to make
funding contributions of up to $108 million over the first three years
of BT LookSmart's operation. While the budget for the joint venture will
be determined by the joint venture's board of directors, we expect that
our financial contributions in 2001 will not exceed our financial
contributions in 2000 of $12.7 million. If we are unable to meet our
financing obligations, our equity ownership of the joint venture will be
proportionately reduced;
. the joint venture will face competition in international markets from a
range of competitors, including AOL Time Warner, Deutsche Telecom,
France Telecom, GoTo, Lycos, Scandinavian Online, Sonera Plaza, Tele
Denmark, UK Plus, Yahoo!, and other search infrastructure, media,
telecommunications and portal companies, many of which have greater
capital resources and local experience in these markets;
. the joint venture may fail to offer locally-relevant search products and
services, which would prevent it from aggregating a large base of
Internet traffic;
. the joint venture faces risks associated with conducting operations in
many different countries, including risks of currency fluctuations,
government and legal restrictions, including privacy and tax laws,
cultural or technical incompatibilities and economic or political
instability;
. the joint venture may be unable to aggregate a large amount of Internet
traffic and generate advertising and other revenue streams from that
traffic;
. the joint venture may fail to establish an effective management team and
hire experienced and qualified personnel in each of the countries in
which it competes;
. we have not previously worked with British Telecommunications and may be
unable to maintain an effective working relationship in the joint
venture due to differences in business goals, assessment of and appetite
for risk or other factors; and
. on November 9, 2000, British Telecommunications announced that it would
split its business into at least two separate companies. We cannot
predict what, if any, impact this split will have on the joint venture.
Many of our advertisers are emerging Internet companies that represent credit
risks
We expect to continue to derive a significant portion of our revenues from
the sale of advertising and listings to Internet companies. Many of these
companies have limited operating histories and are operating at a loss.
Moreover, many of these companies have limited cash reserves and limited
access to additional capital. We have in some cases experienced difficulties
collecting outstanding accounts receivable and, as a result, our reserve for
doubtful accounts receivable as of December 31, 2000 was $4.2 million, an
increase of $3.6 million over December 31, 1999. This increase represents an
increase in the percentage of our total accounts receivable classified as
doubtful accounts compared to the comparable percentage at December 31, 1999.
We may continue
15
to have these difficulties in the future. If any significant part of our
customer base experiences commercial difficulties or is unable or unwilling to
pay our advertising or listing fees for any reason, our business will suffer.
If we are unsuccessful in expanding the network of affiliates using our
directory and search services, we may be unable to increase future revenues
Our success depends on our ability to expand the network of affiliates
using our directory and search services. We have invested, and will continue
to invest, a significant amount of our human and capital resources to expand
this network. However, we cannot assure you that we will maintain and expand
the network of websites using our search infrastructure services on
financially favorable terms, if at all. If we are unsuccessful in doing so,
the reach of our search services, and consequently our ability to generate
advertising revenues, will be seriously harmed. In that event, our business
prospects and results of operations may deteriorate.
We face risks related to expanding into new services and businesses,
particularly our Listings business
To increase our revenues, we will need to expand into new service and
business areas. In this regard, we have expanded our business to include
Express Listing and Subsite Listing services. Our success will depend upon the
extent to which businesses choose to use our Express Listing and Subsite
Listing products. These products are in early stages and we cannot predict
whether they will meet projected levels of revenues in future quarters. Also,
these products will require both modification of existing software and systems
and the creation or acquisition of new software and systems. We may lack the
managerial, editorial and technical resources necessary to expand our service
offerings. For these and other reasons, these initiatives may not generate
sufficient revenues to offset their costs. If we are unable to generate
significant additional revenues from our new business areas, they may harm our
results of operations and financial condition.
A failure to manage and integrate businesses we acquire could divert
management's attention and harm our operations. Acquisitions will likely also
dilute our existing stockholders
If we are presented with appropriate opportunities, we intend to make
additional acquisitions of, or significant investments in, complementary
companies or technologies to increase our technological capabilities and
expand our service offerings. Acquisitions may divert the attention of
management from the day-to-day operations of LookSmart. In addition,
integration of acquired companies into LookSmart could be expensive, time
consuming and strain our managerial resources. It may be difficult to retain
key management and technical personnel of the acquired company during the
transition period following an acquisition. We may not be successful in
integrating any acquired businesses or technologies and these transactions may
not achieve anticipated business benefits.
Acquisitions or other strategic transactions may also result in dilution to
our existing stockholders if we issue additional equity securities and may
increase our debt. For example, as a result of our acquisition of Zeal Media,
Inc. on October 27, 2000, we issued or reserved for issuance 1,363,419 shares
of our common stock, which diluted existing stockholders. We may also be
required to amortize significant amounts of goodwill or other intangible
assets in connection with future acquisitions, which would adversely affect
our operating results.
Our stock price is extremely volatile and investors may not be able to resell
their shares for a profit
The stock market has recently experienced significant price and volume
fluctuations, and the market prices of technology companies, particularly
Internet companies, have been extremely volatile. These broad market and
industry fluctuations may adversely affect the market price of our common
stock, regardless of our actual operating performance. You may not be able to
sell your shares for a profit as a result of a number of factors that may
cause a decline in our stock price, including:
. changes in the market valuations of Internet companies in general and
comparable companies in particular;
16
. quarterly fluctuations in our operating results;
. our potential failure to meet analyst expectations on a quarterly basis;
. changes in ratings or financial estimates by securities analysts;
. announcements of technological innovations, partnerships, acquisitions
or new products or services by us or our competitors; or
. conditions or trends in the Internet that suggest a continuing decline
in the growth rates of advertising-based Internet companies.
In the past, securities class action litigation has often been instituted
after periods of volatility in the market price of a company's securities. A
securities class action suit against us could result in substantial costs and
the diversion of management's attention and resources, regardless of the
outcome.
We may be unable to address capacity constraints on our software and
infrastructure systems in a timely manner
We have developed custom, proprietary software for use by our editors to
create the LookSmart directory, and we also use proprietary and licensed
software to distribute the LookSmart directory and associated pages, and to
serve advertising to those pages. This software may contain undetected errors,
defects or bugs or may fail to operate with other software applications. The
following developments may strain our capacity and result in technical
difficulties with our website or the websites of our distribution affiliates
partners:
. substantial increases in editorial activity or the number of URLs in our
directory;
. customization of our directory for syndication with particular partners;
. substantially increased traffic using our directory; and
. the addition of new features or changes in our directory structure.
If we fail to address these constraints and difficulties in a timely
manner, our advertising and other revenues may decline and our business would
likely suffer. In addition, as we expand our service offerings and enter into
new business areas, we may be required to significantly modify and expand our
software and infrastructure systems. If we fail to accomplish these tasks in a
timely manner, our business will suffer.
The operating performance of our systems is critical to our business and
reputation
Any system failure, including network, software or hardware failure,
whether caused by us, a third party service provider, unauthorized intruders
and hackers, or natural disasters, that causes an interruption in our service
or a decrease in the responsiveness of the web pages that we serve could
result in reduced user traffic, a decline in revenues and damage to our
reputation. Our users, partners and customers depend on Internet service
providers, or ISPs, online service providers and other third parties for
access to the LookSmart directories. These service providers have experienced
significant outages in the past and could experience outages, delays and other
operating difficulties in the future.
In February 1999, we entered into an agreement with GlobalCenter, Inc. (now
Exodus Communications, Inc.) to house our networking and web serving hardware
equipment at their facilities in Sunnyvale, California. In December 2000, we
entered into an agreement with Savvis Communications, Inc. to house additional
networking and web serving hardware. Our networking hardware is now fully
redundant at separate locations. However, we do not presently maintain fully
redundant web serving systems at both locations, so our operations depend on
each of Exodus' and Savvis's ability to protect the systems in its data center
from system failures, earthquake, fire, power loss, water damage,
telecommunications failure, hackers, vandalism and similar events. Neither
Exodus nor Savvis guarantees that our Internet access will be uninterrupted,
error-free or secure. We have deployed intrusion detection and firewall
hardware at each facility to thwart hacker attacks. We have not
17
developed a disaster recovery plan to respond to system failures. Although we
maintain property insurance and business interruption insurance, we cannot
guarantee that our insurance will be adequate to compensate us for all losses
that may occur as a result of any system failure.
If we are unable to compete effectively in the Internet search infrastructure
market, our business and profitability will suffer
We compete in the Internet search infrastructure market, which is
relatively new and highly competitive. We expect competition to intensify as
this market evolves. Many of our competitors have longer operating histories,
larger user bases, longer relationships with consumers, greater brand
recognition and significantly greater financial, technical and marketing
resources than we do. As a result of their greater resources, our competitors
may be in a position to respond more quickly to new or emerging technologies
and changes in consumer requirements and to develop and promote their products
and services more effectively than we do.
The barriers to entry into some segments of the Internet search
infrastructure market are relatively low. As a result, new market entrants
pose a threat to our business, particularly with respect to software-based
search solutions and providing Internet search services to vertical market
segments. We do not own any patented technology that precludes or inhibits
competitors from entering the Internet search infrastructure market. Existing
or future competitors may develop or offer technologies or services that are
comparable or superior to ours, which could harm our competitive position and
business.
We currently face direct competition from companies that provide directory
content, search algorithms, content aggregation and licensing, targeted
advertising and online interactive service capabilities. As we expand the
scope of our Internet services, we will compete directly with a greater number
of Internet search infrastructure providers, content aggregators and other
media companies across a wide range of different online services, including:
. subject-specific websites where competitors may have advantages in
expertise and brand recognition;
. portals that have a branded franchise and a high frequency of repeat
visitors;
. metasearch services and software applications that allow a user to
search the databases of several directories and catalogs simultaneously;
and
. category-based and directory-based services that offer information
search and retrieval capabilities.
To date, the Internet search infrastructure market has been characterized
by intense competition for consumer traffic. This has resulted in the payment
of consumer referral fees by us and others to frequently-used websites, such
as portals and ISPs. If these companies fail to provide these referrals, or
the market for these referrals becomes more competitive so that the cost of
referrals increases, our business and potential profitability could be harmed.
Recent acquisitions and strategic alliances involving our competitors could
reduce traffic on our network
A number of significant acquisitions and other alliances have been
completed or announced in the Internet search and navigation market involving
some of our competitors, including:
. America OnLine's acquisitions of Netscape Communications Corporation and
AOL Time Warner, Inc. and strategic partnership with GoTo.com, Inc.;
. Primedia, Inc.'s acquisition of About.com, Inc.;
. Terra Networks, S.A.'s acquisition of Lycos, Inc.;
. InfoSpace's acquisition of Go2Net;
. The Walt Disney Company's (Go Network) acquisition of a significant
stake in Infoseek Corporation and recently announced agreement with
GoTo.com, Inc. regarding the use of GoTo's search results on the Go
Network portal;
18
. CMGI's acquisition of an interest in AltaVista;
. NBCi's formation from Snap, XOOM.com, NBC.com, NBC Interactive
Neighborhood, AccessHollywood.com, VideoSeeker and a 10% equity stake in
CNBC.com;
. Yahoo, Inc.'s acquisition of Geocities and strategic partnership with
Google;
. Inktomi's acquisition of Ultraseek from the Go Network;
. @Home Network's acquisition of Excite, Inc.; and
. Ask Jeeves' acquisition of Direct Hit Corporation.
Although we cannot predict the effect of these transactions and agreements
on our business 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 capital, brand, marketing and technical
resources than LookSmart. As a result, these competitors may be able to
respond more quickly to new technologies and changes in consumer requirements
and to develop and promote their products and services more effectively than
we can.
We may be unable to execute our business model in international markets
A key component of our strategy is to expand our operations into selected
international markets, both through BT LookSmart in Europe and Asia and
through our direct offerings of search and navigation services in Australia,
Canada and selected countries in Latin America. To date, we have limited
experience in syndicating localized versions of our service offerings in
international markets, and we may be unable to execute our business model in
these markets. In addition, most foreign markets have lower levels of Internet
usage and online advertising than the United States. In pursuing our
international expansion strategy, we face several additional risks, including:
. lower per capita Internet usage and online shopping rates in many
countries abroad, due to a variety of causes such as lower disposable
incomes, lack of telecommunications and computer infrastructure and
questions regarding adequate on-line security for e-commerce
transactions;
. less-developed Internet advertising markets in foreign markets, which
may make it more difficult to generate revenue from the traffic on our
international directories;
. relatively small Internet markets in some countries may prevent us from
aggregating sufficient traffic and advertising revenues and scaling our
business model in those countries;
. competition in international markets from a broad range of competitors,
including Yahoo!, Alta Vista and other United States and foreign
telecommunications firms, search engines, content aggregators and
portals, many of which have greater local experience than we do;
. uncertainty of market acceptance in new regions due to language,
cultural, technological or other factors;
. our potential inability to aggregate a large amount of Internet traffic
and find and develop relationships with advertisers;
. difficulties in recruiting qualified and knowledgeable staff and in
building locally relevant products and services;
. unexpected changes and differences in regulatory, tax and legal
requirements applicable to Internet services; and
. foreign currency fluctuations.
19
Our failure to address these risks adequately could inhibit or preclude our
efforts to expand our business in international markets.
Our management and internal systems may be inadequate to handle the growth of
our business
Our workforce has grown from 55 employees on January 1, 1998 to
approximately 690 employees worldwide on December 31, 2000. However, in
January 2001, we implemented a restructuring plan that resulted in staff
reductions of 172 employees. In addition, many members of our management team
have only recently started in their current positions. Implementation of our
growth strategy requires that we hire additional highly qualified personnel,
particularly in our engineering, international, product development and sales
operations.
Our growth has placed, and will continue to place, a significant strain on
our management, our engineering and product development staff, and our
internal accounting, operational and administrative systems. To manage future
growth, we must continue to improve these systems and expand, train, retain
and manage our employee base. If our systems, procedures and controls are
inadequate to support our operations, our expansion could be slowed. We cannot
assure you that we will be able to manage our growth effectively, and any
failure to do so could harm our business.
Our future success depends on our ability to attract and retain key personnel
Our future success depends, in part, on the continued service of our key
management personnel, particularly Evan Thornley, our Chairman and Chief
Executive Officer, and Tracey Ellery, our President. Mr. Thornley and Ms.
Ellery are husband and wife. The loss of the services of either of these
individuals, or the services of other key employees, could adversely affect
our business. LookSmart does not have employment agreements with Mr. Thornley
and Ms. Ellery, and they do not have stock options or restricted stock subject
to vesting based on continued employment.
Our success also depends on our ability to identify, attract, retain and
motivate highly skilled administrative, technical, editorial, finance and
marketing personnel. In particular, Ned Brody, our Chief Financial Officer,
has tendered his resignation from the Company effective as of March 31, 2001.
We have not yet identified a successor to Mr. Brody and it may take a long
time to successfully recruit a new Chief Financial Officer. Competition for
such personnel, particularly in the San Francisco Bay area, is intense, and we
cannot assure you that we will be able to retain our key employees or that we
can identify, attract and retain highly skilled personnel in the future.
If we become subject to unfair hiring claims, we could be prevented from
hiring needed personnel, incur liability for damages and incur substantial
costs in defending ourselves
Companies in our industry whose employees accept positions with competitors
frequently claim that these competitors have engaged in unfair hiring
practices or that the employment of these persons would involve the disclosure
or use of trade secrets. These claims could prevent us from hiring personnel
or cause us to incur liability for damages. We could also incur substantial
costs in defending ourselves or our employees against these claims, regardless
of their merits. Defending ourselves from these claims could also divert the
attention of our management away from our operations.
We may face liability for intellectual property claims or information
contained in our search infrastructure services, and these claims may be
costly to resolve
We make information available to end users on our search infrastructure
services, both on our website and our distribution affiliates' websites. We
also provide our distribution affiliates with custom-developed software and
software developed by others as part of our service offerings. Although we do
not believe that our website content and services infringe any proprietary
rights of others, we cannot assure you that others will not assert claims
against us in the future or that these claims will not be successful. We or
our distribution affiliates could
20
be subject to claims for defamation, invasion of privacy, negligence,
copyright or trademark infringement, breach of contract or other theories
based on the nature and content of our information and services. These types
of claims have been brought, sometimes successfully, against online service
providers in the past. In addition, we are obligated under some agreements to
indemnify other parties as a result of claims that we infringe on the
proprietary rights of others.
Even if such claims do not result in liability to us or our distribution
affiliates, we could incur significant costs and diversion of management time
in investigating and defending against them. Our insurance may not cover
claims of this type, may not be adequate to cover all costs incurred in
defense of these claims, and may not indemnify us for all liability we incur.
Our business prospects depend on the continued growth in the use of the
Internet
Our business is substantially dependent upon continued growth in the use of
the Internet as a medium for advertising, obtaining information and commercial
transactions. Internet usage and e-commerce may not grow at projected rates
for various reasons, including:
. user inability or frustration in locating and accessing required
information;
. actual or perceived lack of security of information;
. limitations of the Internet infrastructure resulting in traffic
congestion, reduced reliability or increased access costs;
. inconsistent quality of service;
. governmental regulation, such as tax or privacy laws;
. general economic problems in the United States or abroad which decreases
users' disposable income;
. uncertainty regarding intellectual property ownership; and
. lack of appropriate communications equipment.
We believe that capacity constraints caused by growth in the use of the
Internet may, unless resolved, impede further growth in Internet use. Further,
the adoption of the Internet for commerce and communications, particularly by
those individuals and companies that have historically relied upon traditional
means of commerce and communication, generally requires the understanding and
acceptance of a new way of conducting business and exchanging information.
Companies that have already invested substantial resources to conduct commerce
and exchange information through other means may be particularly reluctant or
slow to adopt a new Internet-based strategy that may make their existing
personnel and infrastructure obsolete. If any of the foregoing factors affects
the continuing growth in the use of the Internet, our business could be
harmed.
Privacy-related regulation of the Internet could limit the ways we currently
collect and use personal information which could decrease our advertising
revenues or increase our costs
Internet user privacy has become an issue both in the United States and
abroad. The Federal Trade Commission and government agencies in some states
and countries have been investigating some Internet companies, and lawsuits
have been filed against some Internet companies, regarding their use of
personal information. The European Union has adopted a directive that imposes
restrictions on the collection and use of personal data, guaranteeing citizens
of European Union member states various rights, including the right of access
to their data, the right to know where the data originated and the right to
recourse in the event of unlawful processing. Any laws imposed to protect the
privacy of Internet users may affect the way in which we collect and use
personal information. We could incur additional expenses if new regulations or
court judgments regarding the use of personal information are introduced or if
any regulator chooses to investigate our privacy practices.
21
As is typical with most websites, our website places information, known as
cookies, on a user's hard drive, generally without the user's knowledge or
consent. This technology enables website operators to target specific users
with a particular advertisement and to limit the number of times a user is
shown a particular advertisement. Although some Internet browsers allow users
to modify their browser settings to remove cookies at any time or to prevent
cookies from being stored on their hard drives, many consumers are not aware
of or technically proficient enough to customize these options. In addition,
some Internet commentators, privacy advocates and governmental bodies have
suggested limiting or eliminating the use of cookies. If this technology is
reduced or limited, the Internet may become less attractive to advertisers and
sponsors, which could result in a decline in our revenues.
We and some of our partners retain information about our users. If others
were able to penetrate our network security and gain access to, or in some
other way misappropriate, our users' information, we could be subject to
liability. These claims could result in litigation, our involvement in which,
regardless of the outcome, could require us to expend significant time and
financial resources.
New tax treatment of companies engaged in Internet commerce may adversely
affect the Internet industry and our company
Tax authorities at the international, federal, state and local levels are
currently reviewing the appropriate tax treatment of companies engaged in
Internet commerce. New or revised state tax regulations may subject us to
additional state sales, income and other taxes. We cannot predict the effect
of current attempts to impose sales, income or other taxes on commerce over
the Internet. However, new or revised taxes and, in particular, sales taxes,
would likely increase our cost of doing business and decrease the
attractiveness of advertising and selling goods and services over the
Internet. Any of these events would likely have an adverse effect on our
business and results of operations.
Future sales of our securities may cause our stock price to decline
The market price of our common stock could decline as a result of sales of
substantial amounts of our common stock in the public market, or the
perception that such sales could occur. As of December 31, 2000, approximately
43.5 million shares of common stock were held by non-affiliates and
approximately 48.1 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, 2000, the holders of up to 42.2 million shares of common stock
and warrants to purchase up to approximately 2.1 million shares of common
stock had rights to require us to register those shares under the Securities
Act.
In addition, the Chess Depository Interests, or CDIs, which are publicly
traded on the Australian Stock Exchange under the symbol "LOK", are
exchangeable into shares of LookSmart common stock at a ratio of 20 CDIs per
share of common stock. Holders of CDIs may decide to exchange their CDIs for
shares of LookSmart common stock at any time. In that event, the exchanged
shares of common stock may be immediately available for resale at the option
of the holders in the Nasdaq National Market, which could depress the Nasdaq
market price of LookSmart common stock. As of December 31, 2000, the CDIs
registered for trading on the Australian Stock Exchange were exchangeable into
an aggregate of approximately 15.6 million shares of common stock.
These resales of common stock in the Nasdaq National Market, or the
perception that they may occur, could cause our stock price to decline. These
events may also make it more difficult for us to raise funds through future
offerings of common stock.
Directors, officers and significant stockholders have substantial influence
over LookSmart, which could prevent or delay a change in control
As of December 31, 2000, our executive officers, directors and significant
stockholders and the funds for whom they act as general partner, collectively
owned approximately 48% of the outstanding shares of LookSmart
22
common stock. If these stockholders choose to act or vote together, they will
have the power to influence matters requiring stockholder approval, including
the election of our directors, amendments to our charter and approval of
significant corporate transactions, including mergers or asset sales. This
concentration of ownership may have the effect of discouraging others from
making a tender offer or bid to acquire LookSmart at a price per share that is
above the then-current market price.
The anti-takeover provisions of Delaware's general corporation law and
provisions of our charter and bylaws may discourage a takeover attempt
Our charter and bylaws and provisions of Delaware law may deter or prevent
a takeover attempt, including an attempt that might result in a premium over
the market price for our common stock. Our board of directors has the
authority to issue shares of preferred stock and to determine the price,
rights, preferences and restrictions, including voting rights, of those shares
without any further vote or action by the stockholders. The issuance of
preferred stock, while providing desirable flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
making it more difficult for a third party to acquire a majority of our
outstanding voting stock. In addition, our charter and bylaws provide for a
classified board of directors. These provisions, along with Section 203 of the
Delaware General Corporation Law, could discourage potential acquisition
proposals and could delay or prevent a change of control.
ITEM 2. PROPERTIES
Our headquarters are located in 137,000 square feet of leased office space
in San Francisco, California. The lease term for this office space 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 for a term of one year. In
January 2001, we extended one of these subleases for 30,000 square feet of
space in this facility until December 2001. The rent received on the sublease
is in excess of our obligation under the original lease.
We lease a number of smaller facilities in New York, Los Angeles,
Melbourne, Sydney, Montreal, Copenhagen, Amsterdam, Paris, Berlin and Tokyo.
These facilities have various lease terms extending as far as May 2005.
ITEM 3. LEGAL PROCEEDINGS
In August 2000, the Federal Trade Commission began an inquiry into our
information collection practices on our Inside the Web website. Inside the
Web, or ITW, is a general audience website that hosts free message boards
created by third parties. The inquiry focused on whether we have complied with
the requirements of the Children's Online Privacy Protection Act in
maintaining areas of the ITW site that were allegedly directed to children. In
March 2001, LookSmart and the FTC resolved the matter and executed a consent
decree which requires us to place additional notices on our web properties
regarding online privacy and to pay civil monetary penalties of $35,000. In
March 2001, we voluntarily ceased operating the ITW site as a part of the
corporate restructuring announced in January 2001.
We are not a party to any other 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 2000.
23
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" and Chess Depository Interests, or CDIs, each of which is
exchangeable for 1/20th of a share of common stock, are quoted on the
Australian Stock Exchange under the symbol "LOK." The following table sets
forth the range of high and low sales prices of the common stock for each
period indicated:
HIGH LOW
------ ------
Fiscal 1999:
Third quarter (from August 20) ............................. $40.50 $16.25
Fourth quarter ............................................. $42.06 $24.38
Fiscal 2000:
First quarter .............................................. $72.00 $26.56
Second quarter ............................................. $45.94 $12.50
Third quarter .............................................. $25.50 $11.13
Fourth quarter ............................................. $11.38 $ 1.72
LookSmart had approximately 704 holders of record of common stock as of
December 31, 2000. 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, 2000, a portion of the net proceeds had been used for general
corporate purposes, including working capital, marketing and promotional
activities, expanded operations, new product development and increased
personnel. The remaining proceeds were invested in short-term investments in
order to meet anticipated cash needs for future working capital.
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.
(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 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
series A preferred stock to a bank in connection with a line of credit
agreement for an aggregate purchase price of $534,400.
(4) On February 1, 1998, we issued to one investor a convertible
promissory note in the aggregate amount of $250,000, mandatorily redeemable
for series A preferred stock.
24
(5) On February 5, 1998, we issued to two investors convertible
promissory notes in the aggregate amount of $250,000, mandatorily
redeemable for series A preferred stock.
(6) On March 7, 1998, we issued to one investor a convertible promissory
note in the aggregate amount of $50,000, mandatorily redeemable for series
A preferred stock.
(7) On March 12, 1998, we issued to one investor a convertible
promissory note in the aggregate amount of $75,000, mandatorily redeemable
for series A preferred stock.
(8) On March 26, 1998, we issued a warrant for 1,010,412 shares of
series A preferred stock 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 series A preferred stock.
(10) On April 6, 1998, we issued to one investor a warrant for 336,804
shares for an aggregate purchase price of $56,134 and a convertible
promissory note in the aggregate amount of $500,000, both for series A
preferred stock.
(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 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.
(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 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, 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.
(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 in connection with
an asset purchase.
(17) On April 26, 1999, we issued 75,939 shares of series C preferred
stock to 14 investors for an aggregate of $379,695.
(18) 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.
(19) 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.
(20) On October 27, 2000, in connection with the acquisition of Zeal
Media, Inc., we issued 1,097,284 shares of common stock and reserved
266,135 shares for issuance upon exercise of assumed options and warrants.
(21) From our incorporation to March 1, 2001, we issued options to
purchase an aggregate of 25,156,339 shares of common stock with exercise
prices ranging from $0.00953 to $68.4375 per share. From our incorporation
to March 1, 2001, options to purchase 6,175,273 shares of common stock have
been exercised for an aggregate consideration of $3,130,794.
25
(22) From our incorporation to March 1, 2001, we 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. From our
incorporation to March 1, 2001, warrants to purchase 15,816,508 shares of
preferred and common stock have been exercised for an aggregate
consideration of $2,521,906.
There were no underwriters employed in connection with any of the foregoing
transactions.
The issuances of securities described in (1)-(13), (16)-(20) and (22) were
deemed to be exempt from registration under the Securities Act in reliance on
Section 4(2), Regulation D and/or Regulation S of the Securities Act as
transactions by an issuer not involving a public offering or the offer and
sale of securities to non-U.S. investors. The issuance of securities described
in (14) and (15) were deemed to be exempt from registration in reliance on
Sections 4(2) and 4(6) of the Securities Act. The issuances of securities
described in (21) 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, December 31,
1996 1997 1998 1999 2000
-------------- ------------ ------------ ------------ ------------
(in thousands, except per share amounts)
Statements of Operations
Data:
Net revenues.......... $ 3 $ 949 $ 8,785 $ 48,865 $112,622
Gross profit.......... (87) 519 7,199 41,947 94,965
Total operating
expenses............. 2,739 7,848 19,097 109,065 143,201
Net income (loss)..... (2,900) (7,514) (12,858) (64,663) (62,590)
Net income (loss) per
share--basic and
diluted.............. $ (0.03) $ (0.08) $ (0.68) $ (1.42) $ (0.70)
Shares used in per
share calculation--
basic and diluted.... 115,947 91,589 18,790 45,518 89,111
December 31, December 31, December 31, December 31, December 31,
1996 1997 1998 1999 2000
------------ ------------ ------------ ------------ ------------
Balance Sheet Data:
Working capital
(deficit)............ $ (429) $(1,125) $(6,507) $ 82,688 $ 87,630
Total assets.......... 2,825 2,275 14,090 161,519 182,396
Long-term debt and
capital lease
obligations, net of
current portion...... -- 1,500 1,500 1,423 51,214
Total stockholders'
equity (deficit)..... $2,091 $ (453) $(1,261) $119,552 $ 79,222
26
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 Annual Report on 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".
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 nine 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 insignificant and we
primarily focused on investing in editorial resources and building our web
directory. Until October 1997, our cash requirements were satisfied primarily
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.
In May 1998, we raised a total of approximately $8.3 million in our Series
A and Series B preferred stock financings and established our 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 June 30, 2001. Under this arrangement, Netscape
periodically directs user search traffic to LookSmart for a fixed cost per
thousand referrals.
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 revenue. At December 31, 2000, deferred revenue
associated with the Microsoft contract was $10.1 million. 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
27
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 4 and December 4 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 financing. The proceeds from this financing were used to
increase working capital, to fund operating losses and to enter into strategic
relationships and acquisitions.
In April 1999, as part of a strategic alliance between our two companies,
we acquired certain lines of business and other rights from Guthy-Renker
Internet, LLC 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. Our contractual right to be the exclusive online
distributor of Guthy-Renker products will expire in April 2002.
In June 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 obtained
Internet bulletin board services that generate advertising revenue. As part of
the restructuring announced in January 2001, we discontinued this business in
March 2001. As a result, in the first quarter of 2001 we will incur a charge
of approximately $6.0 million associated with the writeoff of goodwill.
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. In September 2000 and December
2000, we amended two of the agreements to reduce their duration from three to
two years. At December 31, 2000, LookSmart was committed to pay a total of
$5.1 million for the remainder of the contract periods if all five agreements
remain effective throughout their current 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 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 into a three-year licensing agreement with
Excite@Home. Under this agreement, we license our database to Excite@Home.
In August 1999, we completed our 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 Internet portals. In December
2000, we amended this agreement to provide for the inclusion of the LookSmart
directory in Inktomi's search index and to provide for sharing of revenues
derived from Inktomi's distribution of Subsite Listings.
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 in cash and 71,870 shares of our common stock.
This transaction was accounted for as a purchase. Futurecorp's results of
operations subsequent to the closing of the transaction have been consolidated
with ours. Through this business, we provide web-based communication
applications and community building solutions focused primarily in Australia.
In July 2000, we exercised our option to purchase additional shares, bringing
our ownership of the company to approximately 53%.
28
In March 2000, we entered into a three-year agreement with Prodigy
Communications Corporation, which was subsequently acquired by SBC
Communications, Inc. Under this agreement, Prodigy directs user search traffic
to LookSmart for a fixed cost per thousand impressions.
In March 2000, we entered into a two-year agreement with Go2Net, Inc.,
which was subsequently acquired by InfoSpace, Inc. Under this agreement,
Go2Net directs user search traffic to LookSmart for a fixed cost per referral.
In May 2000, we entered into a two-year agreement with Juno Online
Services, Inc. Under this arrangement, Juno directs user search traffic to
LookSmart for a fixed cost per referral.
In July 2000, we entered into a two-year agreement with AltaVista Company.
Under this agreement, AltaVista directs user search traffic to LookSmart for a
fixed cost per thousand impressions and refers potential customers to
LookSmart's listings services for a share of the resulting revenue.
In October 2000, we completed the acquisition of Zeal Media, Inc., a
provider of community-based directories. At the closing, we issued 1,097,284
shares of our common stock, assumed options and warrants to purchase an
additional 266,135 shares of our common stock, and paid $660,144.11 of
outstanding debt.
In January 2001, we announced a restructuring of our management and
operations, including the exit from non-core businesses, such as ITW and
LookSmart Live!, the reorganization of eleven operating groups into four
operating groups, and the reduction of staff by 172 employees. Management
estimates that the total savings from the restructuring is approximately $44.0
million on an annualized basis, and will result in a substantial one-time
charge in the first quarter of 2001.
Revenues and Cost of Revenues
LookSmart is principally organized in four operating segments:
advertising/syndication; licensing; ecommerce and listings.
Advertising/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 (or other advertising format) impressions over the term of the
agreement. We offer advertisers the ability to specify the category of traffic
for their advertisements, and we are able to charge premiums on some
categories based on advertisers' perceptions of economic value. This value is
derived from the location 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 attract
new advertisers as well as re-sign or replace existing advertisers as their
contracts expire. We are currently experiencing and expect continued downward
pressure on advertising prices in the industry generally due to the decline in
advertising expenditures among Internet companies and 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 seasonal. 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.
29
Because advertising revenues represent a significant portion of our total
revenues, fluctuations in advertising revenues due to pricing pressures, our
ability to collect from our customers, 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 results.
However, our costs are substantially 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 revenue source will have a disproportionately large impact on net
income or loss.
Revenues associated with advertising contracts are recognized once
collectibility is established, as delivery occurs (as specified under the
contracts), once all performance obligations have been satisfied and when no
refund obligations exist. Barter does not represent a significant component of
our total revenues.
We generate revenues from syndication agreements by sharing with our
syndication partners advertising sales revenue associated with traffic
referred from the partners to LookSmart. We generally receive the gross
revenues from the advertiser, and then forward a portion of these revenues to
the syndication partner. We work with our Internet Service Provider, or ISP,
and Internet portal partners to "co-brand", or create partner-specific home
pages which have the "look and feel" a partner desires and which provide the
ISP or Internet portal subscriber with fully-functional access to the
LookSmart database. In these cases, LookSmart derives the advertising sales
revenues from the traffic generated by the ISP or Internet portal 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, BT LookSmart (our joint venture with British
Telecommunications), Inktomi, and Excite@Home. Revenues associated with
licensing contracts are recognized as delivery occurs, as specified under the
contracts, and after all performance obligations have been satisfied and no
refund obligation exists. We expect licensing revenues 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.
Ecommerce. The Company's ecommerce revenue is generated primarily by the
sale of merchandise through online stores such as BuyItOnTheWeb (a wholly
owned business unit of LookSmart). Revenue from the sale of merchandise is
reported on a gross basis (net of provisions for returns and refunds). Revenue
is recognized at the time goods are shipped. Associated direct product costs,
including shipping and handling, are reported as cost of revenues. We expect
that ecommerce revenue will represent a larger percentage of total revenues in
2001 than in 2000. Also, under our agreement with Guthy-Renker Corporation,
our primary supplier of ecommerce merchandise, we expect that our ecommerce
marketing costs will increase in the second quarter of 2001.
Listings. The Company's listings revenues are derived from its Subsite and
Express Listings products, which include fees from the expedited written
review of customer URLs, "cost-per-click" arrangements on those URLs, setup
fees, and periodic maintenance fees. Listings revenue also includes partner
commissions derived from our affiliates program. Revenues associated with
listings contracts are recognized once collectibility is reasonably assured,
as delivery of services occurs (as specified under the contracts), once all
performance obligations have been satisfied and when no refund obligation
exists. Any upfront fees collected are recognized over the expected life of
the relationship with the customer. The Company's costs of listings revenue
are primarily the distribution fees paid to partners on subsite and affiliates
"cost-per-click" revenues.
Operating Expenses
We do not track operating expenses by reportable segment, but treat these
as shared overhead of our four reportable segments.
30
Sales and Marketing. Sales and marketing expenses include payments to
syndication partners who are Internet portals, ISP partners and other traffic
providers for directing online users to the LookSmart database. Traffic
payments may 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
may vary significantly depending on the structure of the payment arrangements
between us and our affiliates. When a traffic arrangement is structured so
that we collect the gross advertising revenues and forward a portion to our
partner, 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. Sales and marketing costs also include the payments made to
partners associated with Express Listings. We expect these costs to increase
as we expand our distribution of this product. We expect our revenue sharing
payments to our affiliate and distribution partners to increase as we expand
our distribution. On the other hand, we expect our traffic payments for our
higher cost distribution agreements to decrease over time as we renegotiate or
terminate these agreements.
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 amortization of related unearned
compensation, salaries and associated costs of employment, overhead and
facilities, as well as any bad debt expenses taken for uncollectible trade
receivables. 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 and during 2000, we
capitalized $1.7 million of internal use software costs. We are amortizing
these costs over two years. Amortization relating to internal use software was
$84,000 in 1999 and $654,000 in 2000. 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
amortization of unearned compensation, 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.
General and Administrative. General and administrative expenses include
overhead costs such as executive management, human resources, finance, legal,
investor relations and facilities personnel. These costs include amortization
of unearned compensation, salaries and associated costs of employment,
overhead and facilities. General and administrative expenses include related
consulting and professional service fee