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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 

FORM 10-Q
 

 
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the Quarterly Period Ended June 30, 2011
 
OR
 
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the Transition Period from              to             .
 
Commission File Number: 000-26357
 
 

LOOKSMART, LTD.
(Exact Name of Registrant as Specified in its Charter)
 

 
 
Delaware
 
13-3904355
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
55 Second Street
San Francisco, California 94105
(415) 348-7000
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
 
NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.001 per share
 
Securities registered pursuant to Section 12(g) of the Act:
None
 

 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x      No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large-accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
             
Large accelerated filer
 
o
  
Accelerated filer
 
o
       
Non-accelerated filer
 
o
  
Smaller reporting company
 
x
 
Indicate by check mark whether the registrant is a shell company, as defined in Rule 12b-2 of the Exchange Act.    Yes  o    No  x
 
As of July 29, 2011, there were 17,279,982 shares of the registrant’s common stock outstanding, par value $0.001 per share.
 


 
 

 
 
TABLE OF CONTENTS
 
PART I
1
   
ITEM 1
 
FINANCIAL STATEMENTS
1
       
   
1
       
   
2
       
   
3
       
   
4
       
ITEM 2.
 
14
       
ITEM 3.
 
20
       
ITEM 4.
 
20
       
PART II OTHER INFORMATION
20
   
ITEM 1.
 
20
       
ITEM 1A.
 
20
       
ITEM 2.
 
20
       
ITEM 3.
 
21
       
ITEM 4.
 
21
       
ITEM 5.
 
21
       
ITEM 6.
 
21
       
21
   
21

 
PART I
 
ITEM 1.
FINANCIAL INFORMATION
  
LOOKSMART, LTD. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
 
(In thousands, except per share data)

   
June 30,
2011
   
December
31, 2010
 
ASSETS
 
(Unaudited)
       
Current assets:
           
Cash and cash equivalents
  $ 11,228     $ 22,119  
Short-term investments
    11,254       3,250  
Total cash, cash equivalents and short-term investments
    22,482       25,369  
Trade accounts receivable, net
    2,137       3,267  
Prepaid expenses and other current assets
    656       680  
Total current assets
    25,275       29,316  
Long-term investments
    3,528       1,577  
Property and equipment, net
    2,441       3,082  
Capitalized software and other assets, net
    1,453       1,750  
Total assets
  $ 32,697     $ 35,725  
                 
LIABILITIES & STOCKHOLDERS' EQUITY
               
Current liabilities:
               
Trade accounts payable
  $ 1,330     $ 2,503  
Accrued liabilities
    1,495       2,615  
Deferred revenue and customer deposits
    1,022       1,004  
Current portion of capital lease obligations
    856       1,048  
Total current liabilities
    4,703       7,170  
Capital lease and other obligations, net of current portion
    520       902  
Total liabilities
    5,223       8,072  
Commitment and contingencies
               
Stockholders' equity:
               
Convertible preferred stock, $0.001 par value; Authorized: 5,000 shares at June 30, 2011 and December 31, 2010; Issued and Outstanding: none at June 30, 2011 and December 31, 2010
    -       -  
Common stock, $0.001 par value; Authorized: 80,000 shares at June 30, 2011 and December 31, 2010; Issued and Outstanding: 17,276 shares and 17,222 shares at June 30, 2011 and December 31, 2010, respectively
    17       17  
Additional paid-in capital
    261,987       261,740  
Accumulated other comprehensive gain
    16       1  
Accumulated deficit
    (234,546 )     (234,105 )
Total stockholders' equity
    27,474       27,653  
Total liabilities and stockholders' equity
  $ 32,697     $ 35,725  

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

 
LOOKSMART, LTD. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
(In thousands, except per share data)
 
(Unaudited)

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenue
  $ 6,605     $ 13,017     $ 14,994     $ 26,303  
Cost of revenue
    3,439       7,525       8,094       16,561  
Gross profit
    3,166       5,492       6,900       9,742  
Operating expenses:
                               
Sales and marketing
    554       1,275       1,202       2,429  
Product development and technical operations
    1,550       2,001       3,144       3,993  
General and administrative
    1,041       1,669       2,427       3,360  
Restructuring charge
    -       -       889       -  
Total operating expenses
    3,145       4,945       7,662       9,782  
Income (loss) from operations
    21       547       (762 )     (40 )
Interest income
    24       16       47       33  
Interest expense
    (24 )     (41 )     (53 )     (83 )
Other income, net
    333       44       326       52  
Income (loss) from continuing operations before income taxes
    354       566       (442 )     (38 )
Income tax benefit (expense)
    -       1       1       (5 )
Income (loss) from continuing operations
    354       567       (441 )     (43 )
Income from discontinued operations, net of tax
    -       85       -       178  
Net income (loss)
  $ 354     $ 652     $ (441 )   $ 135  
Net income (loss) per share - Basic and Diluted
                               
Income (loss) from continuing operations
  $ 0.02     $ 0.04     $ (0.03 )   $ -  
Income from discontinued operations, net of tax
    -       -       -       0.01  
Net income (loss) per share - Basic and Diluted
  $ 0.02     $ 0.04     $ (0.03 )   $ 0.01  
Weighted average shares outstanding used in computing basic net income (loss) per share
    17,274       17,157       17,255       17,151  
Weighted average shares outstanding used in computing diluted net income (loss) per share
    17,368       17,192       17,255       17,168  

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

 
LOOKSMART, LTD. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(In thousands)
 
(Unaudited)

   
Six Months Ended June 30,
 
   
2011
   
2010
 
Cash flows from operating activities:
           
Net income (loss)
  $ (441 )   $ 135  
Adjustment to reconcile net loss to net cash provided by (used in) operating activities:
               
Depreciation and amortization
    1,409       1,433  
Share-based compensation
    165       332  
(Gain) loss from sale of assets and other non-cash charges
    46       (228 )
Deferred rent
    (4 )     84  
Gain on closure of settlement fund
    (339 )     -  
Changes in operating assets and liabilities:
               
Trade accounts receivable
    1,039       (939 )
Prepaid expenses and other current assets
    56       (20 )
Trade accounts payable
    (1,173 )     (97 )
Accrued liabilities
    (781 )     (531 )
Deferred revenue and customer deposits
    18       (91 )
Net cash provided by (used in) operating activities
    (5 )     78  
Cash flows from investing activities:
               
Purchase of investments
    (15,367 )     (4,498 )
Proceeds from sale of investments
    5,397       8,262  
Proceeds from sale of equipment
    -       67  
Payments for property, equipment, and capitalized software
    (503 )     (1,863 )
Proceeds from contingent purchase consideration of certain consumer assets
    91       178  
Net cash provided by (used in) investing activities
    (10,382 )     2,146  
Cash flows from financing activities:
               
Principal payments of capital lease obligations
    (570 )     (700 )
Proceeds from issuance of common stock
    66       -  
Net cash used in financing activities
    (504 )     (700 )
Increase (decrease) in cash and cash equivalents
    (10,891 )     1,524  
Cash and cash equivalents, beginning of period
    22,119       22,933  
Cash and cash equivalents, end of period
  $ 11,228     $ 24,457  
Supplemental disclosure of noncash activities:
               
Assets acquired through capital lease obligations
  $ -     $ 363  
Property and equipment received and liability accrued
  $ -     $ 38  
Change in unrealized gain on investments
  $ 15     $ -  

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

 
LOOKSMART, LTD. AND SUBSIDIARIES
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
1. Summary of Significant Accounting Policies
 
Nature of Business
 
LookSmart, Ltd. (“LookSmart” or the “Company”) is a search advertising network solutions company that provides relevant solutions for search advertisers and publishers. LookSmart was organized in 1996 and is incorporated in the State of Delaware.
 
LookSmart operates in a large online search advertising ecosystem serving ads that target user queries on partner sites. The Company operates in the middle of this ecosystem, acquiring search queries from a variety of sources and matching them with the keywords of its search advertising customers. The Company’s largest category of customers has been intermediaries, the majority of which purchase clicks to sell into the affiliate networks of the large search engine providers. Another category of customers are direct advertisers and their agencies, some of whom want conversions or sales from the clicks, while others want unique page views. The last category of customers is self-service advertisers that sign-up online and pay by credit card.
 
The Company offers search advertising customers targeted search via a monitored search advertising distribution network using the Company’s “AdCenter” platform technology. The Company’s search advertising network includes publishers and search advertising customers, including intermediaries and direct advertising customers and their agencies as well as self-service customers in the United States and certain other countries. The Company’s application programming interface (“API”) allows search advertising customers and their advertising agencies to connect any type of marketing or reporting software with minimal effort, for easier access, management, and optimization of search advertising campaigns.
 
The Company also offers publishers licensed private-label search advertiser network solutions based on its AdCenter platform technology (“Publisher Solutions”). Publisher Solutions consist of hosted auction-based ad serving with an ad backfill capability that allows publishers and portals to manage their advertiser relationships, distribution channels and accounts.
 
In the first quarter of 2008, the Company’s management made the decision to exit its remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. The results of operations of consumer product activities, including related gains, have been classified as discontinued operations for all periods presented in the accompanying Unaudited Consolidated Statements of Operations (see Note 2). At June 30, 2011, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology, and other assets.
 
Principles of Consolidation
 
The Unaudited Consolidated Financial Statements as of June 30, 2011 and December 31, 2010, and for the three and six months ended June 30, 2011 and 2010, include the accounts of the Company and its subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.
 
Unaudited Interim Financial Information
 
The accompanying Unaudited Consolidated Financial Statements as of June 30, 2011, and for the three and six months ended June 30, 2011 and 2010, reflect all adjustments that are normal and recurring in nature and, in the opinion of management, are necessary for a fair representation of the Company’s financial position as of June 30, 2011 and the results of operations for the periods shown. These Unaudited Consolidated Financial Statements should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 (“Annual Report”). The Unaudited Consolidated Balance Sheet as of December 31, 2010 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The results of operations for the interim periods ended June 30, 2011 are not necessarily indicative of results to be expected for the full year.
 
Use of Estimates and Assumptions
 
The Unaudited Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”). This requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue, expenses, and contingent assets and liabilities during the reporting period. The Company bases its estimates on various factors and information which may include, but are not limited to, history and prior experience, experience of other enterprises in the same industry, new related events, and current economic conditions and information from third party professionals that is believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. In management’s opinion, all adjustments necessary for a fair statement are reflected in the interim periods presented.
 
Reclassifications
 
Certain amounts in the financial statements for the prior periods have been reclassified to conform to the current presentation. These reclassifications did not change the previously reported net loss, net change in cash and cash equivalents or stockholders’ equity.
 
Investments
 
The Company invests its excess cash primarily in debt instruments of high-quality corporate and government issuers. All highly liquid instruments with maturities at the date of purchase greater than ninety days are considered investments. All instruments with maturities greater than one year from the balance sheet date are considered long-term investments unless management intends to liquidate such securities in the current operating cycle. Such securities are classified as short-term investments. These securities are classified as available-for-sale and carried at fair value.
 
Changes in the value of these investments are primarily related to changes in interest rates and are considered to be temporary in nature. Except for declines in fair value that are not considered temporary, net unrealized gains or losses on these investments are reported as a component of Other Comprehensive Income (Loss) in Stockholders’ Equity. The Company recognizes realized gains and losses upon sale of investments using the specific identification method.

 
Fair Value of Financial Instruments
 
The Company’s estimate of fair value for assets and liabilities is based on a framework that establishes a hierarchy of the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions. The three levels of the hierarchy are as follows:
 
 
Level 1:
Unadjusted quoted market prices for identical assets or liabilities in active markets that we have the ability to access.
 
 
Level 2:
Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, default rates, etc.) or can be corroborated by observable market data.
 
 
Level 3:
Valuations based on models where significant inputs are not observable. The unobservable inputs reflect our assumptions about the assumptions that market participants would use.
 
Revenue Recognition
 
Online search advertising revenue is primarily composed of per transaction fees that the Company charges customers. Revenue also includes revenue share from licensing of private-labeled versions of the Company’s AdCenter Platform.
 
Revenues associated with online advertising products, including Advertiser Networks, are generally recognized once collectability is established, delivery of services has occurred, all performance obligations have been satisfied, and no refund obligations exist that management is aware of. The Company pays distribution network partners based on clicks on the advertiser’s ad that are displayed on the websites of these distribution network partners. These payments are called traffic acquisition costs (“TAC”) and are included in cost of revenue. The revenue derived from these arrangements that involve traffic supplied by distribution network partners is reported gross of the payment to the distribution network partners. This revenue is reported gross due to the fact that the Company is the primary obligor to the advertisers who are the customers of the advertising service.
 
The Company also enters into agreements to provide private-labeled versions of its AdCenter platform technology. These license arrangements may include some or all of the following elements: revenue-sharing based on the publisher’s customer’s monthly revenue generated through the AdCenter application; upfront fees; monthly minimum fees; and other license fees. The Company recognizes upfront fees over the term of the arrangement or the expected period of performance, other license fees over the term of the license, and revenue-sharing portions over the period in which such revenue is earned. In all cases, revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectability of the resulting receivable is reasonably assured.
 
The Company provides a provision against revenue for estimated reductions resulting from billing adjustments and customer refunds. The amounts of these provisions are evaluated periodically based upon customer experience and historical trends. The allowance included in trade accounts receivable, net is not significant and $0.2 million at June 30, 2011 and December 31, 2010, respectively.
 
Deferred revenue is recorded when payments are received in advance of performance in underlying agreements. Customer deposits are recorded when customers make prepayments for online advertising.
 
Allowance for Doubtful Accounts
 
The Company maintains an allowance for doubtful accounts for estimated losses resulting from customers failing to make required payments. This valuation allowance is reviewed on a periodic basis to determine whether a provision or reversal is required. The review is based on factors including the application of historical collection rates to current receivables and economic conditions. The Company will record an increase or reduction of its allowance for doubtful accounts if collection rates or economic conditions are more or less favorable than it anticipated. Additional allowances for doubtful accounts may be required if there is deterioration in past due balances, if economic conditions are less favorable than the Company anticipated or for customer-specific circumstances, such as bankruptcy. The allowance for doubtful accounts included in trade accounts receivable, net is $0.2 million at June 30, 2011 and December 31, 2010. Bad debt allowance included in sales and marketing expense is not significant for the three and six months ended June 30, 2011 and 2010.
 
Concentrations, Credit Risk and Credit Risk Evaluation
 
Concentration of Credit Risk
 
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, investments, and accounts receivable. As of June 30, 2011 and December 31, 2010, the Company placed its cash equivalents and investments primarily through one financial institution, City National Bank (“CNB”), and mitigated the concentration of credit risk by placing percentage limits on the maximum portion of the investment portfolio which may be invested in any one investment instrument. These amounts exceed federally insured limits at June 30, 2011 and December 31, 2010. The Company has not experienced any credit losses on these cash equivalents and investment accounts and does not believe it is exposed to any significant credit risk on these funds. The fair value of these accounts is subject to fluctuation based on market prices.
 
Credit Risk, Customer and Vendor Evaluation
 
Accounts receivable are typically unsecured and are derived from sales to customers. The Company performs ongoing credit evaluations of its customers and maintains allowances for estimated credit losses. The Company applies judgment as to its ability to collect outstanding receivables based primarily on management’s evaluation of the customer’s financial condition and past collection history and records a specific allowance. In addition, the Company records an allowance based on the length of time the receivables are past due. Historically, such losses have been within management’s expectations.
 
One customer accounted for 15% and 21% of gross accounts receivable at June 30, 2011 and December 31, 2010, respectively.

 
Revenue Concentrations
 
The following table reflects revenue from customers located in countries or regions that accounted for more than 10% of net revenue:
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
United States
    78 %     59 %     69 %     62 %
Europe, Middle East and Africa
    13 %     24 %     24 %     21 %
Canada
    **       12 %     **       13 %
                                 
** Less than 10%
                               
 
LookSmart derives its revenue from two service offerings, or “products”: Advertiser Networks and Publisher Solutions. The percentage distributions between the two service offerings are as follows:
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Advertiser Networks
    96 %     93 %     96 %     93 %
Publisher Solutions
    4 %     7 %     4 %     7 %
 
The following table reflects the percentage of revenue attributed to customers who accounted for 10% or more of net revenue:
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Company 1
    13 %     11 %     14 %     11 %
Company 2
    11 %     11 %     **       11 %
Company 3
    **       **       **       11 %
                                 
** Less than 10%
                               
 
The Company derives its revenue primarily from its relationships with significant distribution network partners. The following table reflects the distribution partners that accounted for more than 10% of TAC:
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Distribution Partner 1
    **       26 %     **       17 %
Distribution Partner 2
    **       **       11     **  
                                 
** Less than 10%
                               
 
Property and Equipment
 
Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets as follows:
 
Computer equipment
3 to 4 years
Furniture and fixtures
5 to 7 years
Software
2 to 3 years
 
Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the lease term.
 
Internal Use Software Development Costs
 
The Company capitalizes external direct costs of materials and services consumed in developing and obtaining internal-use computer software and the payroll and payroll-related costs for employees who are directly associated with, and who devote time to, developing the internal-use computer software.
 
Management exercises judgment in determining when costs related to a project may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the amortization period for the capitalized costs, which is generally 3 years. The Company expects to continue to invest in internally developed software and to capitalize such costs.

 
Impairment of Long-Lived Assets
 
The Company reviews long-lived assets held or used in operations, including property and equipment and capitalized software development costs, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. Subject assets are tested for impairment at the lowest level of operations that generate cash flows that are largely independent of the cash flows from those of other groups of asset and liabilities. Management has determined that the equity of its single reporting unit is the lowest level of operation at which independent cash flows can be identified. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Impairment, if any, is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. Assets to be disposed of are reported at the lower of carrying amount or fair value less cost to dispose.
 
As of June 30, 2011 and December 31, 2010, management believes long-lived assets were not impaired.
 
Traffic Acquisition Costs
 
The Company enters into agreements of varying durations with its distribution network partners that display the Company’s listings ads on their sites in return for a percentage of the revenue-per-click that the Company receives when the ads are clicked on those partners’ sites.
 
The Company also enters into agreements of varying durations with third party affiliates. These affiliate agreements provide for variable payments based on a percentage of the Company’s revenue or based on a certain metric, such as number of searches or paid clicks.
 
The Company records TAC expenses as cost of revenue and TAC are expensed based on the volume of the underlying activity or revenue, multiplied by the agreed-upon price or rate.
 
Share-Based Compensation
 
The Company recognizes share-based compensation costs for all share-based payment transactions with employees, including grants of employee stock options and employee stock purchases related to the Employee Stock Purchase Plan, over the requisite service period based on their relative fair values. The Company estimates the fair value of share-based payment awards on the grant date using the Black-Scholes method. The value of the portion of the award that is ultimately expected to vest is recognized as expense in the Company’s Unaudited Consolidated Statements of Operations over the requisite service periods. Share-based compensation expense recognized for the three and six months ended June 30, 2011 were $0.1 million and $0.2 million, respectively, and $0.2 million and $0.4 million for the three and six months ended June 30, 2010, respectively, which was related to stock grants, options and employee stock purchases.
 
Forfeitures are estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is determined at the end of each fiscal quarter, based on historical rates.
 
Income Taxes
 
The Company accounts for income taxes using the liability method. Under the liability method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. The Company records liabilities, where appropriate, for all uncertain income tax positions. The Company recognizes interest and penalties related to unrecognized tax benefits within operations as income tax expense.
 
Comprehensive Gain
 
Other comprehensive gain as of June 30, 2011 and December 31, 2010, consists of unrealized gains on marketable securities categorized as available-for-sale.
 
Net Income (Loss) per Common Share
 
Basic and diluted net income (loss) per share is calculated using the weighted average shares of common stock outstanding.
 
Segment Information
 
The Company operates in a single segment, search advertising, and conducts business worldwide. While the Company operates under one operating segment, management reviews revenue under two product offerings—Advertiser Networks and Publisher Solutions.
 
As of June 30, 2011 and December 31, 2010, all of the Company’s accounts receivable, intangible assets and deferred revenue related to the search advertising segment. All long-lived assets are located in the United States or Canada.
 
Recent Accounting Pronouncements
 
With the exception of those stated below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended June 30, 2011, as compared to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, that are of material significance, or have potential material significance, to the Company.
 
In May 2011, the Financial Accounting Standards Board (“FASB”) issued a new accounting standard on fair value measurements that clarifies the application of existing guidance and disclosure requirements, changes certain fair value measurement principles and requires additional disclosures about fair value measurements. This new guidance is to be applied prospectively. The Company is required to adopt this standard as of the beginning of 2012. Adoption of this new guidance is not expected to have a material impact on the Company’s results of operations, financial position or liquidity.
 
In June 2011, the FASB issued a new accounting standard on the presentation of comprehensive income. The new standard requires the presentation of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The new standard also requires presentation of adjustments for items that are reclassified from other comprehensive income to net income in the statement where the components of net income and the components of other comprehensive income are presented. This new guidance is to be applied retrospectively. The Company is required to adopt this standard as of the beginning of 2012. Adoption of this new guidance is not expected to have a material impact on the Company’s results of operations, financial position or liquidity.
 
 
2. Discontinued Operations
 
On January 22, 2007, the Company completed the sale of Net Nanny to Content Watch, Inc. (“Content Watch”). The sale proceeds were comprised of contingent purchase consideration that was realized at future dates based on the amount of revenue received by Content Watch. The Company recorded contingent purchase consideration of $0.1 million for both the three and six months ended June 30, 2010 which has been classified as discontinued operations in the accompanying Unaudited Consolidated Statements of Operations. Under the terms of the Content Watch agreement, the contingent purchase consideration ended in 2010.
 
As of June 30, 2011 the Company owns the Wisenut search engine technology, intellectual property rights in such technology and other assets.
 
3. Cash, Cash Equivalents and Short-Term Investments
 
The following table summarizes the Company’s cash and available-for-sale securities’ amortized cost and estimated fair value by significant investment category as of June 30, 2011 and December 31, 2010 (in thousands):
 
   
Amortized Cost and Estimated Fair Value
 
   
June 30
   
December 31
 
   
2011
   
2010
 
Cash and cash equivalents:
           
Cash
  $ 8,456     $ 9,435  
Cash equivalents
               
Money market mutual funds
    973       35  
Certificates of deposit
    -       2,000  
Commercial paper
    1,799       10,649  
Total cash equivalents
    2,772       12,684  
Total cash and cash equivalents
    11,228       22,119  
Short-term investments:
               
Corporate bonds
    507       -  
Certificates of deposit
    5,050       2,250  
Commercial paper
    5,697       1,000  
Total short-term investments
    11,254       3,250  
Long-term investments:
               
Corporate bonds
    2,103       1,577  
Certificates of deposit
    1,425       -  
Total long-term investments
    3,528       1,577  
Total cash and available-for-sale securities
  $ 26,010     $ 26,946  
 
Realized gains and realized losses were not significant for any of the three and six month periods ended June 30, 2011 and 2010. As of June 30, 2011 and December 31, 2010, there were no significant unrealized losses on investments. The cost of all securities sold is based on the specific identification method.
 
The contractual maturities of cash equivalents and short-term investments at June 30, 2011 and December 31, 2010 were less than one year. The contractual maturity of the long term investments is 1.30 years as of June 30, 2011 (see Note 11).
 
The Company typically invests in highly-rated securities, and its policy generally limits the amount of credit exposure to any one issuer. When evaluating the investments for other-than-temporary impairment, the Company reviews such factors as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer, and the Company’s intent to sell, or whether it is more likely than not it will be required to sell the investment before recovery of the investment’s amortized cost basis. During the three and six months ended June 30, 2011 and 2010, the Company did not recognize any impairment charges on outstanding investments. As of June 30, 2011, the Company does not consider any of its investments to be other-than-temporarily impaired.
 
4. Property and Equipment
 
Property and equipment consisted of the following at June 30, 2011 and December 31, 2010 (in thousands):
 
   
June 30, 2011
   
December 31, 2010
 
   
Cost
   
Accumulated
Depreciation
   
Net Book
Value
   
Cost
   
Accumulated
Depreciation
   
Net Book
Value
 
Computer equipment
  $ 9,443     $ (7,231 )   $ 2,212     $ 9,224     $ (6,411 )   $ 2,813  
Furniture and fixtures
    75       (61 )     14       75       (59 )     16  
Software
    1,239       (1,225 )     14       1,239       (1,220 )     19  
Leasehold improvements
    308       (107 )     201       308       (74 )     234  
Total
  $ 11,065     $ (8,624 )   $ 2,441     $ 10,846     $ (7,764 )   $ 3,082  

 
Depreciation expense on property and equipment for the three and six months ended June 30, 2011, including property and equipment under capital lease, was $0.4 million and $0.9 million, respectively, and is recorded in operating expenses. Depreciation expense on property and equipment for the three and six months ended June 30, 2010, including property and equipment under capital lease, was $0.5 million and $0.9 million, respectively. Equipment under capital lease totaled $3.9 million and $4.3 million as of June 30, 2011 and December 31, 2010, respectively. Depreciation expense on equipment under capital lease was $0.3 million and $0.6 million for the three and six months ended June 30, 2011, respectively, and was $0.3 million and $0.7 million for the three and six months ended June 30, 2010, respectively. Additionally, accumulated depreciation on equipment under capital lease was $3.0 million and $2.8 million as of June 30, 2011 and December 31, 2010, respectively.
 
5. Capitalized Software and Other Assets
 
The Company’s capitalized software and other assets are as follows at June 30, 2011 and December 31, 2010 (in thousands):
 
   
June 30, 2011
   
December 31, 2010
 
   
Gross Amount
   
Accumulated Amortization
   
Net Book Value
   
Gross Amount
   
Accumulated Amortization
   
Net Book Value
 
Capitalized software
  $ 6,469     $ (5,077 )   $ 1,392     $ 6,206     $ (4,550 )   $ 1,656  
Amortizable purchased technology
    78       (78 )     -       78       (78 )     -  
Other assets
    61       -       61       94       -       94  
    $ 6,608     $ (5,155 )   $ 1,453     $ 6,378     $ (4,628 )   $ 1,750  
 
Capitalized software consists of external direct costs of materials and services consumed in developing and obtaining internal-use computer software and the payroll and payroll-related costs for employees who are directly associated with, and who devote time to, developing the internal-use computer software and is amortized over three years. Amortization expense was $0.3 million and $0.5 million for the three and six months ended June 30, 2011, respectively, and $0.3 million and $0.6 million for the three and six months ended June 30, 2010, respectively.
 
6. Accrued Liabilities
 
Accrued liabilities consisted of the following as of June 30, 2011 and December 31, 2010 (in thousands):
 
   
June 30,
   
December 31,
 
   
2011
   
2010
 
Accrued distribution and partner costs
  $ 1,036     $ 1,473  
Accrued compensation and related expenses
    345       513  
Accrued professional service fees
    112       222  
Other
    2       407  
Total accrued liabilities
  $ 1,495     $ 2,615  
 
7. Restructuring Charges
 
In January 2011, the Company recorded $0.9 million in pre-tax restructuring charges associated with the termination of approximately 20 full-time positions. All restructuring charges have been classified as such on the Unaudited Consolidated Statement of Operations. The cash payments associated with the January 2011 restructuring liability were $0.8 million for both the three and six months ended June 30, 2011. The $0.1 million remaining cash payments associated with the restructuring liability is included in accrued compensation and related expenses and will be paid through the third quarter of 2011.
 
8. Capital Lease and Other Obligations
 
Capital lease and other obligations consist of the following at June 30, 2011 and December 31, 2010 (in thousands):
 
   
June 30,
   
December 31,
 
   
2011
   
2010
 
Capital lease obligations
  $ 1,214     $ 1,784  
Deferred rent
    162       166  
Total capital lease and other obligations
    1,376       1,950  
Less: current portion of capital lease obligations
    (856 )     (1,048 )
Capital lease and other obligations, net of current portion
  $ 520     $ 902  
 
Capital Lease Obligations
 
City National Bank
 
In April 2007, the Company entered into a master equipment lease agreement with CNB for an original amount of up to $5.0 million for the purchase of computer equipment. The lease expired on April 30, 2010, at which time the Company had drawn down approximately $4.9 million of the available lease line of credit. Interest on the capital leases was calculated using interest rates ranging from 4.32% to 7.95% per annum. Effective as of September 30, 2009, the master equipment lease agreement includes two financial covenants, with which the Company was in compliance as of June 30, 2011.
 
 
The agreements with CNB, consisting of an outstanding standby letter of credit (“SBLC”) and a master equipment lease agreement, contain cross-default provisions, whereby a default under one is deemed a default for the other, and are secured by a general lien on all assets of the Company. As of June 30, 2011 and December 31, 2010, the Company was not in default on either agreement with CNB (see Note 9).
 
9. Commitments and Contingencies
 
As of June 30, 2011, future minimum payments under all capital and operating leases are as follows (in thousands):
 
   
CNB
Capital Lease
   
Operating
Leases
   
Total
 
Six months ending December 31, 2011
    508       298       806  
Years ending December 31,
                       
2012
    618       517       1,135  
2013
    144       537       681  
2014
    -       556       556  
Total minimum payments
    1,270     $ 1,908     $ 3,178  
Less: amount representing interest
    (56 )                
Present value of net minimum payments
    1,214                  
Less: current portion
    (856 )                
Long-term portion of capital lease obligations
  $ 358                  
 
Operating Lease
 
In August 2009, the Company entered into an agreement to sublease office space for its headquarters in San Francisco, California, under an operating lease that commenced in November 2009 and expires on December 30, 2014. In addition to the scheduled base rent payments, the Company is also responsible for varying amounts of operating and property tax expenses.
 
Letters of Credit
 
At June 30, 2011 and December 31 2010, the Company has an outstanding SBLC related to the security of a building lease for $0.3 million. The SBLC contains two financial covenants, with which the Company was in compliance as of June 30, 2011.
 
Purchase Obligations
 
In October 2009, the Company entered into a Master Services Agreement and related Service Level Agreement for IT data center services for a two year term, expiring January 2012. The contractual obligations under the agreement include recurring charges of $0.9 million each year.
 
Guarantees and Indemnities
 
During its normal course of business, the Company has made certain guarantees, indemnities and commitments under which it may be required to make payments in relation to certain transactions. These indemnities include intellectual property and other indemnities to the Company’s customers and distribution network partners in connection with the sales of its products, and indemnities to a lessor in connection with facility leases for certain claims arising from such facility or lease.
 
Officer and Director Indemnification
 
The Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was, serving, at the Company’s request, in such capacity, to the maximum extent permitted under the laws of the State of Delaware. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. However, the Company maintains directors and officers insurance coverage that may contribute, up to certain limits, a portion of any future amounts paid for indemnification of directors and officers. The Company believes the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal. Historically, the Company has not incurred any losses or recorded any liabilities related to performance under these types of indemnities.
 
Legal Proceedings
 
The Company is involved, from time to time, in various legal proceedings arising from the normal course of business activities. Although the results of litigation and claims cannot be predicted with certainty, the Company does not expect resolution of these matters to have a material adverse impact on its consolidated results of operations, cash flows or financial position unless stated otherwise. However, an unfavorable resolution of a matter could, depending on its amount and timing, materially affect its results of operations, cash flows or financial position in a future period. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense costs, diversion of management resources and other factors.
 
Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc
 
In 2008, the Company established a Settlement Fund related to a class action lawsuit in which the Company was named as a defendant, Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc (the “Fund”). In the second quarter of 2011, the Company determined that all settlements related to the Fund had been paid and reversed the balance recorded in accrued liabilities and recorded $0.3 million in non-operating income related to closure of the Settlement Fund. This amount is included in other income for the three and six months ended June 30, 2011.
 
10. Stockholders’ Equity
 
Share-Based Compensation
 
Stock Option Plans
 
On June 19, 2007, the stockholders approved the LookSmart 2007 Equity Incentive Plan (the “2007 Plan”). Under the 2007 Plan, the Company may grant incentive stock options, nonqualified stock options, stock appreciation rights and stock rights to employees, directors and consultants. Share-based incentive awards are provided under the terms of these four plans (collectively, the “Plans”).
 
The Company’s Plans are administered by the Compensation Committee of the Board of Directors. Awards under the Plans principally include at-the-money options and fully vested restricted stock. The number of shares reserved for issuance under the Plans was approximately 4.3 million and 4.5 million shares of common stock at June 30, 2011 and December 31, 2010, respectively. There were 1.5 million shares available to be granted under the Plans at June 30, 2011.

 
Share-based compensation expense recorded during the three and six months ended June 30, 2011 and 2010 was included in the Company’s Unaudited Consolidated Statement of Operations as follows (in thousands):
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Sales and marketing
  $ 2     $ 18     $ 2     $ 38  
Product development and technical operations
    42       77       86       183  
General and administrative
    46       68       77       111  
Total share-based compensation expense
    90       163       165       332  
Amounts capitalized as software development costs
    6       10       16       24  
Total share-based compensation
  $ 96     $ 173     $ 181     $ 356  
 
Total unrecognized share-based compensation expense related to share-based compensation arrangements at June 30, 2011was $0.9 million and is expected to be recognized over a weighted-average period of approximately 3.2 years. The total fair value of equity awards vested during the three and six months ended June 30, 2011 was $0.1 million and $0.2 million, respectively, and $0.2 million and $0.4 million during the three and six months ended June 30, 2010, respectively.
 
Option Awards
 
Stock option activity under the Plans during the three and six months ended June 30, 2011 is as follows:
 
   
Shares
   
Weighted-
Average
Exercise Price
Per Share
   
Weighted-
Average
Remaining
Contractual
Term
   
Aggregate
Intrinsic
Value
 
   
(in thousands)
         
(in years)
   
(in thousands)
 
Options outstanding at December 31, 2010
    2,922     $ 3.20              
Granted
    227       1.78              
Excercised
    (30 )     1.15              
Expired/forfeited
    (442 )     2.46              
Options outstanding at March 31, 2011
    2,677     $ 3.22              
Granted
    375       1.85              
Excercised
    (5 )     1.17              
Expired/forfeited
    (337 )     3.74              
Options outstanding at  June 30, 2011
    2,710     $ 2.97       5.92     $ 74  
Vested and expected to vest at June 30, 2011
    2,460     $ 3.09       5.86     $ 71  
Exercisable at June 30, 2011
    1,658     $ 3.77       5.60     $ 60  
 
The aggregate intrinsic values in the table above represent the total pre-tax intrinsic value (the difference between the market price of the Company’s stock on the last trading day of the period and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holder had all option holders exercised their options at year-end. The intrinsic value amount changes with changes in the fair market value of the Company’s stock.
 
The following table summarizes information about stock options outstanding at June 30, 2011:
 
     
Options Outstanding
   
Options Exercisable
 
Price Ranges
   
Shares
   
Weighted-
Average
Remaining
Contractual Term
   
Weighted-
Average
Exercise
Price
Per Share
   
Shares
   
Weighted-
Average
Exercise
Price
Per Share
 
                 
(in thousands)
   
(in years)
         
(in thousands)
       
$ 1.02       -     $ 1.51       659       6.26     $ 1.40       272     $ 1.29  
  1.52       -       2.91       910       6.47       1.96       275       2.34  
  3.07       -       4.33       824       5.88       3.46       794       3.47  
  4.45       -       20.55       317       3.80       7.87       317       7.87  
                          2,710       5.92       2.97       1,658       3.77  

 
Stock Awards
 
The Company did not issue restricted stock during the three months ended June 30, 2011 and 2010 and the six months ended June 30, 2011. During the six months ended June 30, 2010, the Company issued 13 thousand shares of fully vested restricted stock, with a weighted average grant date fair value of $1.03 per share, under the 2007 Plan. The Company recorded share-based compensation for stock awards of zero for the three months ended June 30, 2011 and 2010 and the six months ended June 30, 2011 and $13 thousand for the six months ended June 30, 2010.
 
Employee Stock Purchase Plan
 
In July 2009, the 2009 Employee Stock Purchase Plan (the “2009 ESPP”) was approved by the shareholders. Under the 2009 ESPP, the Company is authorized to issue up to 500 thousand shares of Common Stock to employees of the Company. Under the 2009 ESPP, substantially all employees may purchase the Company’s common stock through payroll deductions at a price equal to 85 percent of the lower of the fair market value at the beginning of the offering period or at the end of each applicable purchase period. Each offering period is 6 months and consists of one purchase period. ESPP contributions are limited to a maximum of 15 percent of an employee’s eligible compensation, and ESPP participants are limited to purchasing a maximum of 5,000 shares per purchase period. Share-based compensation expense under the 2010 ESPP was not significant for three and six months ended June 30, 2011 and 2010. As of June 30, 2011, 61 thousand shares have been issued under the 2009 ESPP Plan.
 
Share-Based Compensation Valuation Assumptions
 
The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option valuation model. The weighted average assumptions used in the Black-Scholes option valuation model and the weighted average grant date fair value per share for employee stock options were as follows:
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Volatility
    67.7 %     64.9 %     67.5 %     64.8 %
Risk-free interest rate
    1.47 %     1.68 %     1.50 %     1.68 %
Expected term (years)
    4.05       3.84       4.03       3.85  
Expected dividend yield
    -       -       -       -  
Weighted average grant date fair value
  $ 0.93     $ 0.71     $ 0.92     $ 0.71  
 
As share-based compensation expense recognized in the Unaudited Consolidated Statement of Operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
 
Exercise of Employee Stock Options and Purchase Plans
 
There were 5 thousand and 35 thousand options exercised in the three and six months ended June 30, 2011. There were no options exercised in the three and six months ended June 30, 2010. The Company issues new shares of common stock upon exercise of stock options. No income tax benefits have been realized from exercised stock options.
 
 
11. Fair Value Measurements
 
Fair Value of Financial Assets
 
The Company’s financial assets measured at fair value on a recurring basis subject to disclosure requirements at June 30, 2011 and December 31, 2010 were as follows (in thousands):
 
   
Balance at
June 30, 2011
   
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
 
Cash equivalents:
                 
Money market mutual funds
  $ 973     $ 973     $ -  
Commercial paper
    1,799       -       1,799  
      2,772       973       1,799  
Short-term investments:
                       
Corporate bonds
    507       -       507  
Certificates of deposit
    5,050       -       5,050  
Commercial paper
    5,697       -       5,697  
      11,254       -       11,254  
Long-term investments:
                       
Corporate bonds
    2,103       -       2,103  
Certificate of deposit
    1,425       -       1,425  
      3,528       -       3,528  
                         
Total financial assets measured at fair value
  $ 17,554     $ 973     $ 16,581  
                         
   
Balance at
December 31,
2010
   
Quoted Prices
In Active
Markets for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
 
Cash equivalents:
                       
Money market mutual funds
  $ 35     $ 35     $ -  
Certificates of deposit
    2,000       -       2,000  
Commercial paper
    10,649       -       10,649  
      12,684       35       12,649  
Short-term investments:
                       
Certificates of deposit
    2,250       -       2,250  
Commercial paper
    1,000       -       1,000  
      3,250       -       3,250  
Long-term investments:
                       
Corporate bonds
    1,577       -       1,577  
Total financial assets measured at fair value
  $ 17,511     $ 35     $ 17,476  
 
Investments
 
For investments that have quoted market prices in active markets, the Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. The Company receives the quoted market prices from a third party, nationally recognized pricing service (“pricing service”). When quoted market prices are unavailable, the Company utilizes a pricing service to determine a single estimate of fair value, which is mainly for its fixed maturity investments. The fair value estimates provided from this pricing service are included in the amount disclosed in Level 2 of the hierarchy. The Company bases all of its estimates of fair value for assets on the bid price as it represents what a third party market participant would be willing to pay in an arm’s length transaction.
 
The Company validates the prices received from the pricing service using various methods including, applicability of Federal Deposit Insurance Corporation or other national government insurance or guarantees, comparison of proceeds received on individual investments subsequent to reporting date, prices received from publicly available sources, and review of transaction volume data to confirm the presence of active markets. The Company does not adjust the prices received from the pricing service unless such prices are determined to be inconsistent. At June 30, 2011 and December 31, 2010, the Company did not adjust prices received from the pricing service.
 
Trade accounts receivable, net: The carrying value reported in the Unaudited Consolidated Balance Sheets is net of allowances for doubtful accounts and returns which estimate customer non-performance risk.
 
Trade accounts payable and accrued liabilities: The carrying value reported in the Unaudited Consolidated Balance Sheets for these items approximates their fair value, which is the likely amount which the liability with short settlement periods would be transferred to a market participant with a similar credit standing as the Company.
 
12. Related Party Transactions
 
In addition to the fees paid as a director of the Company, Dr. Jean-Yves Dexmier was paid fees totaling $0.1 million and $0.2 million in each of the three and six month periods ended June 30, 2011 and 2010, respectively, in connection with his services as the Company’s Chief Executive Officer.
 
 
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Forward-Looking Statements
 
The following discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and the Notes to those statements which appear elsewhere in this Quarterly Report on Form 10-Q. The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believes,” “intends,” “expects,” “anticipates,” “plans,” “may,” “will” and similar expressions to identify forward-looking statements. Discussions containing forward-looking statements may be found in the material set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections of this report. All forward-looking statements, including, but not limited to, projections, expectations or estimates concerning our business, including demand for our products and services, mix of revenue sources, ability to control and/or reduce operating expenses, anticipated gross margins and operating results, cost savings, product development efforts, general outlook of our business and industry, future profits or losses, competitive position, share-based compensation, and adequate liquidity to fund our operations and meet our other cash requirements, are inherently uncertain as they are based on our expectations and assumptions concerning future events. These forward-looking statements are subject to numerous known and unknown risks and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including but not limited to, the possibility that we may fail to maintain or grow our listings advertiser base and/or distribution network, that existing and potential distribution partners may opt to work with, or favor the products of, competitors if our competitors offer more favorable products or pricing terms, that we may be unable to grow our online search advertising revenue and/or find alternative sources of revenue, that we may be unable to attain or maintain customer acceptance of our publisher solutions products, that changes in the distribution network composition may lead to decreases in query volumes, that we may be unable to maintain or improve our query volume, match rate, number of paid clicks, average revenue per click, conversion rate or other ad network metrics, that we may be unable to achieve or maintain profitability, that we may be unable to retain our existing credit facilities or obtain new credit facilities, that we may be unable to attract and retain key personnel, that we may have unexpected increases in costs and expenses, or that one or more of the other risks described below in the section entitled “Risk Factors” and elsewhere in this report may occur.
 
All forward-looking statements in this report are made as of the date hereof, based on information available to us as of the date hereof, and except as required by applicable law, we assume no obligation to update any forward-looking statements.
 
Critical Accounting Policies and Estimates
 
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are discussed in our Annual Report on Form 10-K for the year ended December 31, 2010. As of June 30, 2011, there had been no material changes to our critical accounting policies and estimates.
 
Business Overview
 
LookSmart is a search advertising network solutions company that provides relevant solutions for search advertising customers. LookSmart was organized in 1996 and is incorporated in the State of Delaware.
 
LookSmart operates in a large online search advertising ecosystem serving ads that target user queries on partner sites. We operate in the middle of this ecosystem, acquiring search queries from a variety of sources and matching them with the keywords of our search advertising customers. Our largest category of customers has been intermediaries, the majority of which purchase clicks to sell into the affiliate networks of the large search engine providers. Another category of customers are direct advertisers and their agencies whose objective is to obtain conversions or sales from the clicks, while others want unique page views. The last category of customers is self-service advertisers that sign-up online and pay by credit card.
 
LookSmart offers search advertising customers targeted search via a monitored search advertising distribution network using the Company’s “AdCenter” platform technology. The Company’s search advertising network includes publishers and search advertising customers, including intermediaries and direct advertising customers and their agencies as well as self-service customers in the United States and certain other countries. The Company’s application programming interface (“API”) allows search advertising customers and their advertising agencies to connect any type of marketing or reporting software with minimal effort, for easier access, management, and optimization of search advertising campaigns.
 
LookSmart also offers publishers licensed private-label search advertiser network solutions based on its AdCenter platform technology (“Publisher Solutions”). Publisher Solutions consist of hosted auction-based ad serving with an ad backfill capability that allows publishers and portals to manage their advertiser relationships, distribution channels and accounts.
 
In the first quarter of 2008, management made the decision to exit its remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. The results of operations of consumer product activities, including related gains, have been classified as discontinued operations for all periods presented in the accompanying Unaudited Consolidated Statements of Operations (see Note 2). At June 30, 2011, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology, and other assets.

 
Results of Operations
 
Overview of the Three and Six Months Ended June 30, 2011
 
The following table sets forth selected information concerning our results of operations for the periods indicated:
 
   
Three Months Ended June 30,
 
   
2011
   
% of Revenue
   
2010
   
% of Revenue
   
Dollar
Change
   
%
Change
 
Revenue
  $ 6,605       100.0 %   $ 13,017       100.0 %   $ (6,412 )     (49 %)
Cost of revenue
    3,439       52.1 %     7,525       57.8 %     (4,086 )     (54 %)
Gross profit
    3,166       47.9 %     5,492       42.2 %     (2,326 )     (42 %)
Operating expenses:
                                               
Sales and marketing
    554       8.4 %     1,275       9.8 %     (721 )     (57 %)
Product development and technical operations
    1,550       23.5 %     2,001       15.4 %     (451 )     (23 %)
General and administrative
    1,041       15.8 %     1,669       12.8 %     (628 )     (38 %)
Total operating expenses
    3,145       47.7 %     4,945       38.0 %     (1,800 )     (36 %)
Income from operations
    21       0.2 %     547       4.2 %     (526 )     (96 %)
Non-operating income, net
    333       5.0 %     19       0.1 %     314       1653 %
Income from continuing operations before income taxes
    354       5.2 %     566       4.3 %     (212 )     (37 %)
Income tax benefit
    -       0.0 %     1       0.0 %     (1 )     (100 %)
Income from continuing operations
    354       5.2 %     567       4.3 %     (213 )     (38 %)
Income from discontinued operations
    -       0.0 %     85       0.7 %     (85 )     (100 %)
Net income
  $ 354       5.2 %   $ 652       5.0 %   $ (298 )     (46 %)
                                                 
                                                 
   
Six Months Ended June 30,
 
      2011    
% of Revenue
      2010    
% of Revenue
   
Dollar
Change
   
%
Change
 
Revenue
  $ 14,994       100.0 %   $ 26,303       100.0 %   $ (11,309 )     (43 %)
Cost of revenue
    8,094       54.0 %     16,561       63.0 %     (8,467 )     (51 %)
Gross profit
    6,900       46.0 %     9,742       37.0 %     (2,842 )     (29 %)
Operating expenses:
                                               
Sales and marketing
    1,202       8.0 %     2,429       9.2 %     (1,227 )     (51 %)
Product development and technical operations
    3,144       21.0 %     3,993       15.2 %     (849 )     (21 %)
General and administrative
    2,427       16.2 %     3,360       12.8 %     (933 )     (28 %)
Restructuring charge
    889       5.9 %     -       0.0 %     889       0 %
Total operating expenses
    7,662       51.1 %     9,782       37.2 %     (2,120 )     (22 %)
Loss from operations
    (762 )     (5.1 %)     (40 )     (0.2 %)     (722 )     1805 %
Non-operating income, net
    320       2.1 %     2       0.0 %     318       15900 %
Loss from continuing operations before income taxes
    (442 )     (3.0 %)     (38 )     (0.2 %)     (404 )     1063 %
Income tax benefit (expense)
    1       0.0 %     (5 )     0.0 %     6       (120 %)
Loss from continuing operations
    (441 )     (3.0 %)     (43 )     (0.2 %)     (398 )     926 %
Income from discontinued operations
    -       0.0 %     178       0.7 %     (178 )     (100 %)
Net income (loss)
  $ (441 )     (3.0 %)   $ 135       0.5 %   $ (576 )     (427 %)
 
Revenue
 
Revenue is derived from two service offerings or “products” of LookSmart Ltd. (the “Company”): Advertiser Networks and Publisher Solutions. Total revenue and revenue from Advertiser Networks and Publisher Solutions for the three and six months ended June 30, 2011 and 2010, were as follows (in thousands):
 
   
Three Months Ended June 30,
 
   
2011
   
% of Revenue
   
2010
   
% of Revenue
   
Dollar Change
   
% Change
 
Advertiser Networks
  $ 6,313       96 %   $ 12,100       93 %   $ (5,787 )     (48 %)
Publisher Solutions
    292       4 %     917       7 %     (625 )     (68 %)
Total revenue
  $ 6,605       100 %   $ 13,017       100 %   $ (6,412 )     (49 %)
                                                 
   
Six Months Ended June 30,
 
      2011    
% of Revenue
      2010    
% of Revenue
   
Dollar Change
   
% Change
 
Advertiser Networks
  $ 14,460       96 %   $ 24,533       93 %   $ (10,073 )     (41 %)
Publisher Solutions
    534       4 %     1,770       7 %     (1,236 )     (70 %)
Total revenue
  $ 14,994       100 %   $ 26,303       100 %   $ (11,309 )     (43 %)
 
The decrease in Advertiser Networks revenue for the three and six months ended June 30, 2011 as compared to the same periods in 2010 is attributed to a decline in paid clicks and average revenue-per-click (“RPC”). RPC and paid click changes were the result of a continued decline in revenue from our intermediaries in the comparable periods. Yahoo! Partners, our largest customer group, continued to be affected significantly by reduced payments following the Yahoo!-Bing Search Alliance integration which consequently resulted in lower revenues to us. Total paid clicks decreased 23% to 146 million for the three months ended June 30, 2011, compared to 190 million for the three months ended June 30, 2010. During the same three month period, average RPC decreased 32%, from $0.064 to $0.043, while RPC decreased 22% in the second quarter of 2011 compared to the first quarter of 2011. Total paid clicks decreased 33% to 292 million for the six months ended June 30, 2011, compared to 434 million for the six months ended June 30, 2010. During the same six month period, average RPC decreased 12%, from $0.056 to $0.050. Going forward, we will continue to attempt to increase our revenue primarily with our intermediaries and through performance based pricing models targeting our direct advertising customers and their agencies.

 
The decrease in Publisher Solutions revenue for the three and six months ended June 30, 2011 as compared to the same periods in 2010 is attributed to reduced revenue from IAC Search and Media, Inc. (“IAC”) related to the termination of an agreement with IAC on October 31, 2010. We did not record any Publisher Solutions revenue from IAC during the three and six months ended June 30, 2011, compared to $0.6 million, or 69% of Publisher Solutions revenue, and $1.3 million, or 71% of Publisher solutions revenue, during the three and six months ended June 30, 2010, respectively.
 
Cost of Revenue and Gross Margin
 
Cost of revenue, consisting of TAC, costs paid to our distribution network partners, connectivity costs, hosting expenses, commissions paid to advertising agencies, and credit card fees were as follows for the three and six months ended June 30, 2011 and 2010 (in thousands):
 
   
Three Months Ended June 30,
 
   
2011
   
% of Revenue
   
2010
   
% of Revenue
   
Dollar Change
   
% Change
 
Traffic acquisition costs
  $ 3,044       46 %   $ 7,034       54 %   $ (3,990 )     (57 %)
Other costs
    395       6 %     491       4 %     (96 )     (20 %)
Total cost of revenue
  $ 3,439       52 %   $ 7,525       58 %   $ (4,086 )     (54 %)
Traffic acquisition costs as percentage of Advertiser Network revenue
            48.2 %             58.1 %                
                                                 
   
Six Months Ended June 30,
 
      2011    
% of Revenue
      2010    
% of Revenue
   
Dollar Change
   
% Change
 
Traffic acquisition costs
  $ 7,303       49 %   $ 15,424       59 %   $ (8,121 )     (53 %)
Other costs
    791       5 %     1,137       4 %     (346 )     (30 %)
Total cost of revenue
  $ 8,094       54 %   $ 16,561       63 %   $ (8,467 )     (51 %)
Traffic acquisition costs as percentage of Advertiser Network revenue
            50.5 %             62.9 %                
 
Our TAC decrease as a percentage of associated revenue in 2011 is primarily attributed to optimization of bids/prices paid for different sources of traffic and keywords.
 
Our other costs of revenue, which consists primarily of co-location costs and credit card processing fees, decreased due to the significant duplicate costs incurred during the first half of 2010 associated with the move to a new co-location facility.
 
Operating Expenses
 
Operating expenses for the three and six months ended June 30, 2011 as compared to the same period in 2010 decreased $1.8 million and $2.1 million, respectively. The decrease is largely due to lower headcount resulting from a reduction in workforce in the first quarter of 2011. For the remainder of 2011, planned headcount increases in sales, product development and account management may result in comparatively higher operating expenses, however, expenses will continue to be closely evaluated relative to operating margin.
 
 
Operating expenses consist of sales and marketing, product development and technical operations, general and administrative, and restructuring charges for the three months ended June 30, 2011 and 2010; and were as follows (in thousands):
 
   
Three Months Ended June 30,
 
   
2011
   
% of Revenue
   
2010
   
% of Revenue
   
Dollar Change
   
% Change
 
Sales and marketing
  $ 554       8 %   $ 1,275       10 %   $ (721 )     (57 %)
Product development and technical operations
    1,550       24 %     2,001       15 %     (451 )     (23 %)
General and administrative
    1,041       16 %     1,669       13 %     (628 )     (38 %)
Total operating expenses
  $ 3,145       48 %   $ 4,945       38 %   $ (1,800 )     (36 %)
                                                 
   
Six Months Ended June 30,
 
      2011    
% of Revenue
      2010    
% of Revenue
   
Dollar Change
   
% Change
 
Sales and marketing
  $ 1,202       8 %   $ 2,429       9 %   $ (1,227 )     (51 %)
Product development and technical operations
    3,144       21 %     3,993       15 %     (849 )     (21 %)
General and administrative
    2,427       16 %     3,360       13 %     (933 )     (28 %)
Restructuring charge
    889       6 %     -       0 %     889       0 %
Total operating expenses
  $ 7,662       51 %   $ 9,782       37 %   $ (2,120 )     (22 %)
 
Sales and Marketing
 
Sales and marketing expenses include salaries, commissions, share-based compensation and other costs of employment for our sales force, sales administration and customer service staff and marketing personnel, overhead, facilities, allocation of depreciation and the provision for, and reductions of, the allowance for doubtful trade receivables. Sales and marketing expenses also include the costs of advertising, trade shows, public relations activities and various other activities supporting our customer acquisition efforts.
 
The reduction in sales and marketing expenses for the three and six months ended June 30, 2011, is primarily due to lower compensation related expense associated with lower headcount, and a reduction in marketing expenses.
 
Product Development and Technical Operations
 
Product development and technical operations expense includes all costs related to the continued operations, development and enhancement of our core technology product, the AdCenter platform. The AdCenter is used to operate both our own Advertiser Network and other publishers’ client networks, and is licensed to publishers to operate their own network. These costs include salaries and associated costs of employment, including share-based compensation, depreciation, overhead, and facilities. Costs related to the development of software for internal use in the business, including salaries and associated costs of employment are capitalized after certain milestones have been achieved and amortized over a three year period once the project is placed in service. Software licensing and computer equipment depreciation related to supporting product development and technical operations functions are also included in product development and technical operations expense.
 
Capitalized software development costs include the costs to develop software for internal use, excluding costs associated with research, training and testing.
 
Product development and technical operations and capitalized software development costs for the three and six months ended June 30, 2011 and 2010 were as follows:
 
   
Three Months Ended June 30,
 
   
2011
   
% of Revenue
   
2010
   
% of Revenue
   
Dollar Change
   
% Change
 
Product development and technical operations costs
  $ 1,671       26 %   $ 2,188       17 %   $ (516 )     (24 %)
Capitalized software development costs
    (121 )     (2 %)     (187 )     (2 %)     65       (35 %)
Total product development and technical operations expense
  $ 1,550       24 %   $ 2,001       15 %   $ (451 )     (23 %)
                                                 
   
Six Months Ended June 30,
 
      2011    
% of Revenue
      2010    
% of Revenue
   
Dollar Change
   
% Change
 
Product development and technical operations costs
  $ 3,407       23 %   $ 4,369       17 %   $ (962 )     (22 %)
Capitalized software development costs
    (263 )     (2 %)     (376 )     (2 %)     113       (30 %)
Total product development and technical operations expense
  $ 3,144       21 %   $ 3,993       15 %   $ (849 )     (21 %)
 
The reduction in product development and technical operations expense, net of capitalized software development costs for the three and six months ended June 30, 2011, is primarily due to lower compensation related expense associated with lower headcount, and lower depreciation expense, which was partially offset by lower capitalized software development.
 
General and Administrative
 
General and administrative expenses include costs of executive management, human resources, finance, facilities, and desktop support personnel. These costs include salaries and associated costs of employment, including share-based compensation, overhead, facilities and allocation of depreciation. General and administrative expenses also include legal, insurance, tax and accounting, consulting and professional services fees.
 
 
The reduction in general and administrative expenses for the three and six months ended June 30, 2011, is due to lower compensation-related expense associated with lower headcount, lower audit, legal, and insurance expenses, partially offset by increased travel costs.
 
Other Items
 
The table below sets forth other continuing operations data for the three and six months ended June 30, 2011 and 2010 (in thousands):
 
   
Three Months Ended June 30,
 
   
2011
   
% of Revenue
   
2010
   
% of Revenue
   
Dollar Change
   
% Change
 
Non-operating income (expense), net
                                   
Interest income
  $ 24       0 %   $ 16       0 %   $ 8       50 %
Interest expense
    (24 )     0 %     (41 )     0 %     17       (41 %)
Other income, net
    333       5 %     44       0 %     289       657 %
Total non-operating income, net
  $ 333       5 %   $ 19       0 %   $ 314       1653 %
                                                 
Income tax expense
  $ -       0 %   $ 1       0 %   $ (1 )     0 %
                                                 
   
Six Months Ended June 30,
 
      2011    
% of Revenue
      2010    
% of Revenue
   
Dollar Change
   
% Change
 
Non-operating income (expense), net
                                               
Interest income
  $ 47       0 %   $ 33       0 %   $ 14       42 %
Interest expense
    (53 )     0 %     (83 )     0 %     30       (36 %)
Other income, net
    326       2 %     52       0 %     274       527 %
Total non-operating income, net
  $ 320       2 %   $ 2       0 %   $ 318       15900 %
                                                 
Income tax (expense) benefit
  $ 1       0 %   $ (5 )     0 %   $ 6       (120 %)
 
Interest Income and Expense
 
Interest income, which includes income from our cash, cash equivalents and investments, increased an insignificant amount in the three and six months ended June 30, 2011 from the three and six months ended June 30, 2010. This increase was driven primarily by a shift in the portfolio to longer-term investments and average yields earned during the period.
 
Interest expense, primarily consisting of interest paid on capital leases, decreased an insignificant amount during the three and six months ended June 30, 2011 as compared to the three and six months ended June 30, 2010. This decrease was primarily due to a reduction in capital lease obligations.
 
Other Income
 
In 2008, the Company established a Settlement Fund related to a class action lawsuit in which the Company was named as a defendant, Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc (the “Fund”). In the second quarter of 2011, the Company determined that all settlements related to the Fund had been paid. The Fund was closed on June 30, 2011 and the Company recorded $0.3 million in non-operating income related to the closure. This amount is included in other income for the three and six months ended June 30, 2011.
 
Income Tax Expense
 
Due to our utilizable net operating losses and other tax affects, our income tax expense primarily consists of minimum state taxes.
 
Income from Discontinued Operations, Net of Tax
 
In January 2007, the Company completed the sale of Net Nanny to Content Watch, Inc. (“Content Watch”). The sale proceeds were comprised of contingent purchase consideration that may be realized at future dates based on the amount of revenue received by Content Watch. The Company recorded contingent purchase consideration of $0.1 million for the each of the three and six months ended June 30, 2010. Under the terms of the Content Watch agreement, the contingent purchase consideration ended in 2010. Contingent purchase consideration has been classified as gain on disposal.
 
During 2008, we sold the Wisenut trademark and related domain names. As of June 30, 2011 we continue to own the Wisenut search engine technology and its intellectual property rights in such technology and other assets.
 
 
Liquidity and Capital Resources
 
Increase (decrease) in cash and cash equivalents:
 
   
Six Months Ended June 30,
 
   
2011
   
2010
   
Change
 
Net cash provided by (used in) operating activities
  $ (5 )   $ 78     $ (83 )
Net cash provided by (used in) investing activities
    (10,382 )     2,146       (12,528 )
Net cash used in financing activities
    (504 )     (700 )     196  
Increase (decrease) in cash and cash equivalents
  $ (10,891 )   $ 1,524     $ (12,415 )
 
Cash, cash equivalents and short- and long-term investment balances were as follows as of June 30, 2011 and December 31, 2010 (in thousands):
 
   
June 30,
   
December 31,
       
   
2011
   
2010
   
Change
 
Cash and cash equivalents
  $ 11,228     $ 22,119     $ (10,891 )
Short-term investments
    11,254       3,250       8,004  
Long-term investments
    3,528       1,577       1,951  
Total
  $ 26,010     $ 26,946     $ (936 )
% of total assets
    80 %     75 %        
Total assets
  $ 32,697     $ 35,725          
 
At June 30, 2011, we had $26 million of cash, cash equivalents and short- and long-term marketable investments. Cash equivalents and short- and long-term marketable investments are comprised of highly liquid debt instruments of the U.S. government, commercial paper, time deposits, money market mutual funds and U.S. corporate securities. We actively monitor the depository institutions that hold our cash and cash equivalents and the institutions of whose debt instruments we hold. Our investment policy, which is reviewed annually by our Board of Directors, primarily emphasizes safety of principal while secondarily on maximizing yield on those funds. We can provide no assurances that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial markets. These balances may exceed the Federal Deposit Insurance Corporation insurance limits. While we monitor the cash balances in our operating accounts and adjust the cash balances as appropriate, these cash balances could be impacted if the underlying financial institutions fail or could be subject to other adverse conditions in the financial markets. See Note 3 to the Unaudited Consolidated Financial Statements, “Cash and Available for Sale Securities,” which describes further the composition of our cash, cash equivalents and short- and long-term investments.
 
Cash, cash equivalents and short-and-long-term investments decreased $1.0 million to $26 million at June 30, 2011, from $27 million at December 31, 2010 primarily due to the loss from continuing operations, the use of capital to acquire equipment, principal payments on capital leases, and decreased accounts payable and accrued liabilities, largely offset by a decrease in accounts receivable.
 
Our primary source of liquidity is our cash, cash equivalents, short-and long-term investments, and cash flow from operations. We believe that our existing cash, cash equivalents, short- and long-term investments and cash from operations will be sufficient to satisfy our current anticipated cash requirements through at least the next 12 months, if not longer. Our liquidity could be negatively affected by a decrease in demand for our services beyond the current quarter, and changes in customer buying behavior. In addition, our liquidity could be negatively affected if we are in default under our credit facilities and are required to pay the lenders cash in an amount equal to the capital lease balance, or are required to identify restricted cash equal to the capital lease balance, plus an outstanding standby letter of credit. Also, if the banking system or the financial markets continue to remain volatile, our investment portfolio may be impacted and the values and liquidity of our investments could be adversely affected. In addition, we may seek to raise additional capital through public or private debt or equity financings in order to fund our operations and capital expenditures, take advantage of favorable business opportunities, develop and upgrade our technology infrastructure, develop new product and service offerings, take advantage of favorable conditions in capital markets or respond to competitive pressures. In addition, unanticipated developments in the short term requiring cash payments, including the acquisition of businesses with negative cash flows, may necessitate additional financing. We cannot be assured that additional financing will be available on terms favorable to us, or at all. If we issue additional equity or convertible debt securities, our existing stockholders may experience substantial dilution.
 
Operating Activities
 
Cash used in operating activities in the six months ended June 30, 2011 consisted of our net loss adjusted for certain non-cash items, including depreciation, amortization, share-based compensation expense, as well as the effect of changes in working capital and other activities. Cash used in operations in the first half of 2011 was $5 thousand and consisted of a net loss of $0.4 million, adjustments for non-cash items of $1.6 million and cash used by working capital and other activities of $1.2 million. Adjustments for non-cash items primarily consisted of $1.4 million of depreciation and amortization expense on property and equipment and internally developed software and $0.2 million of share-based compensation expense. In addition, changes in working capital activities primarily consisted, of a $2.3 million decrease in accounts payable and accrued liabilities partially offset by a net decrease of $1.0 million in accounts receivable. The decrease in accounts payable and accrued liabilities was primarily due to reduced TAC, gain on closure of settlement fund, and lower operating expenses. The decrease in accounts receivable is primarily attributed to the decrease in revenue and improvement in collections.
 
Cash provided by operating activities in the six months ended June 30, 2010 consisted of our net income adjusted for certain non-cash items, including depreciation, amortization, share-based compensation expense, gains on sale of assets, as well as the effect of changes in working capital and other activities. Cash provided by operations in the first half of 2010 was $0.1 million and consisted of a net income of $0.1 million, adjustments for non-cash items of $1.6 million and cash used by working capital and other activities of $1.7 million. Adjustments for non-cash items primarily consisted of $1.4 million of depreciation and amortization expense on property and equipment and internally developed software, $0.3 million of share-based compensation expense, partially offset by a $0.2 million gain on sale of assets. In addition, changes in working capital activities primarily consisted of a net increase of $0.9 million in accounts receivable and a $0.6 million decrease in accounts payable and accrued liabilities. The increase in accounts receivable is primarily attributed to an increase in invoiced customer revenue. The decrease in accounts payable and accrued liabilities was primarily due to the timing of vendor payments.
 
Investing Activities
 
Cash used in investing activities in the first half of 2011 of $10.4 million was primarily attributed to $10.0 million net purchase of investments. Capital expenditures in the first half of 2011 consisted of $0.3 million for equipment acquired during the quarter and an investment of $0.2 million in internally developed software related to our AdCenter platform technology.
 
 
Cash provided by investing activities in the first half of 2010 of $2.1 million was primarily attributed to $3.8 million of net proceeds from investments, partially offset by $1.8 million of capital expenditures. Capital expenditures for the first half of 2010 consisted of $0.8 million for equipment received in 2009, for which a liability was accrued in 2009, $0.7 million for equipment acquired during the first half of 2010, an investment of $0.4 million in internally developed software related to our AdCenter platform technology, partially offset by $0.1 million in proceeds from sale of equipment.
 
Financing Activities
 
Cash used in financing activities primarily consisted of $0.5 million in the first half of 2011, and $0.7 million in the first half of 2010, and is primarily attributed to scheduled lease payments.
 
Credit Arrangements
 
We have an outstanding standby letter of credit (“SBLC”) issued by City National Bank (“CNB”) of approximately $0.3 million at June 30, 2011, related to security of a building lease.
 
On April 30, 2010, our master equipment lease agreement with CNB of $5.0 million expired. As of April 30, 2010, we had drawn down approximately $4.9 million of the available lease line of credit.
 
Our agreements with CNB, consisting of the SBLC and master equipment lease agreement, contain cross-default provisions whereby a default under one is deemed a default for the other, and are secured by a general lien on all assets of the Company. As of June 30, 2011, we are in compliance with both agreements with CNB.
 
Off-Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements as defined in Regulation S-K Item 303(a)(4), investments in special-purpose entities or undisclosed borrowings or debt. Additionally, we are not a party to any derivative contracts or synthetic leases.
 
Contractual Obligations and Commercial Commitments
 
In comparison with our Annual Report on Form 10-K for the year ended December 31, 2010, we believe that there have been no significant changes in contractual obligations or commercial commitments outside the ordinary course of business, during the six months ended June 30, 2011.
 
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Pursuant to Item 305(e) of Regulation S-K, we are not required to provide information regarding quantitative and qualitative disclosures about market risk.
 
ITEM 4.
CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in rules promulgated under the Securities Exchange Act of 1934, as amended) for our Company. Based on their evaluation as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in this Quarterly Report on Form 10-Q is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and Form 10-Q, and (ii) is accumulated and communicated to the Company’s management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
 
Changes in Internal Controls
 
There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) during the quarter ended June 30, 2011, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
Limitations on the Effectiveness of Controls
 
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a Company have been detected. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives, and the Chief Executive Officer and the Chief Financial Officer have concluded that these controls and procedures are effective at the “reasonable assurance” level. 

PART II
 
ITEM 1.
LEGAL PROCEEDINGS
 
None.
 
ITEM 1A.
RISK FACTORS
 
Pursuant to Item 1A of Form 10-Q we are not required to provide information regarding material changes from the risk factors previously disclosed in our Form 10-K for the year ended December 31, 2010.
 
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
None.

 
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
 
None.
 
ITEM 4.
(REMOVED AND RESERVED)
 
ITEM 5.
OTHER INFORMATION
 
None.
 
ITEM 6.
EXHIBITS
 
Please see the exhibit index following the signature page of this report.
 
SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
LOOKSMART, LTD.
 
Dated: August 3, 2011
 
 
By:
/s/    William O’Kelly
 
 
William O’Kelly
 
 
Senior Vice President Operations and Chief Financial Officer
 
 
EXHIBIT INDEX
Exhibits
 
Number
 
Description of Document
     
3.1
 
Restated Certificate of Incorporation (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on November 9, 2010).
     
3.2
 
Bylaws (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on August 14, 2000).
     
4.1
 
Form of Specimen Stock Certificate (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on November 14, 2005).
     
4.2++
 
Forms of Stock Option Agreement used by the Registrant in connection with grants of stock options to employees, directors and other service providers in connection with the Amended and Restated 1998 Stock Plan (Filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on October 22, 2004).
     
4.3++
 
Form of cover sheet for use with Stock Option Agreement for grants of stock options to executives in connection with the Company’s Executive Team Incentive Plan, Plan Year 2006 (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on May 10, 2006).
     
4.4++
 
Form of cover sheet for use with stock option agreement for grants of stock options to executives in connection with the Company’s Executive Team Incentive Plan, Plan Year 2007 (Filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on March 2, 2007).
     
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
 
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
101.INS**
 
XBRL Instance Document
     
101.SCH**
 
XBRL Taxonomy Extension Schema
     
101.CAL**
 
XBRL Taxonomy Extension Calculation Linkbase
     
101.LAB**
 
XBRL Taxonomy Extension Label Linkbase
     
101.PRE**
 
XBRL Taxonomy Extension Presentation Linkbase
 
 
 
(*)
Filed herewith
(**)
Pursuant to applicable securities laws and regulations, we are deemed to have complied with the reporting obligation relating to the submission of interactive data files in such exhibits and are not subject to liability under any anti-fraud provisions of the federal securities laws as long as we have made a good faith attempt to comply with the submission requirements and promptly amend the interactive data files after becoming aware that the interactive data files fail to comply with the submission requirements. In accordance with Rule 406T of Regulation S-T, the information in these exhibits is furnished and deemed not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.
(++)
Management contract or compensatory plan or arrangement.
 
 
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