U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

 

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended September 30, 2014

 

OR

 

¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Transition Period from              to             .

 

Commission File Number: 000-26357

 

LOOKSMART, LTD.

(Exact Name of Registrant as Specified in its Charter)

 

 

Delaware		13-3904355
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

50 California Street, 16^th Floor

San Francisco, California 94108

(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 of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No ¨

 

Indicate by check mark 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x     No ¨

 

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		¨		Accelerated filer		¨
Non-accelerated filer		¨		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 ¨    No x

 

As of November 14, 2014 there were 5,768,851 shares of the registrant’s common stock outstanding, par value $0.001 per share.

 

 

TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1	FINANCIAL STATEMENTS
	UNAUDITED CONSOLIDATED BALANCE SHEETS	3
	UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS	4
	UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS	5
	UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS	6
	NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS	7
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	23
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	29
ITEM 4.	CONTROLS AND PROCEDURES	30
PART II. OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	30
ITEM 1A.	RISK FACTORS	31
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	53
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	54
ITEM 4.	MINE SAFETY DISCLOSURES	54
ITEM 5.	OTHER INFORMATION	54
ITEM 6.	EXHIBITS	54
SIGNATURE		55
EXHIBIT INDEX		56

 

 

PART I

 

ITEM 1. FINANCIAL STATEMENTS

 

LOOKSMART, LTD.

CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

 

		September 30, 2014				December 31, 2013
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	1,157			$	2,789
Short-term investments			158				3,102
Total cash, cash equivalents and short-term investments			1,315				5,891
Trade accounts receivable, net			456				606
Prepaid expenses and other current assets			495				1,077
Total current assets			2,266				7,574
Long-term investments			-				154
Property and equipment, net			3,865				3,831
Other assets, net			85				87
Total assets		$	6,216			$	11,646
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable		$	793			$	739
Accrued liabilities			361				444
Deferred revenue and customer deposits			1,006				1,002
Current portion of capital lease obligations			39				-
Total current liabilities			2,199				2,185
Long-term portion of deferred rent			105				186
Total liabilities			2,304				2,371
Commitment and contingencies			-				-
Stockholders' equity:
Convertible preferred stock, $0.001 par value; Authorized: 5,000 shares; Issued and Outstanding: none at September 30, 2014 and December 31, 2013			-				-
Common stock, $0.001 par value; Authorized: 80,000 shares; Issued and Outstanding: 5,769 shares at both September 30, 2014 and December 31, 2013			17				17
Additional paid-in capital			262,507				262,502
Accumulated other comprehensive loss			(288	)			(154	)
Accumulated deficit			(258,075	)			(253,016	)
Treasury stock at cost:  130 shares and 32 shares at September 30, 2014 and December 31, 2013, respectively			(249	)			(74	)
Total stockholders' equity			3,912				9,275
Total liabilities and stockholders' equity		$	6,216			$	11,646

 

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

 

 

LOOKSMART, LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
Revenue		$	1,311			$	1,642			$	3,779			$	5,188
Cost of revenue			648				1,129				2,038				3,487
Gross profit			663				513				1,741				1,701
Operating expenses:
Sales and marketing			398				264				1,243				550
Product development and technical operations			1,180				830				3,597				2,230
General and administrative			472				422				2,113				2,413
Restructuring charge			7				9				23				31
Total operating expenses			2,057				1,525				6,976				5,224
Loss from operations			(1,394	)			(1,012	)			(5,235	)			(3,523	)
Non-operating income (expense), net
Interest income			7				87				81				128
Interest expense			-				-				(7	)			(9	)
Other income (expense), net			85				(20	)			102				(11	)
Loss from operations before income taxes			(1,302	)			(945	)			(5,059	)			(3,415	)
Income tax expense			-				(7	)			-				(7	)
Net loss		$	(1,302	)		$	(952	)		$	(5,059	)		$	(3,422	)
Net loss per share - Basic and Diluted		$	(0.23	)		$	(0.17	)		$	(0.88	)		$	(0.59	)
Weighted average shares outstanding used in computing basic and diluted net loss per share			5,722				5,739				5,727				5,758

 

The accompanying notes are an integral part of these Unaudited Consolidated Financialements.

 

 

LOOKSMART, LTD.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

(Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
Net loss		$	(1,302	)		$	(952	)		$	(5,059	)		$	(3,422	)
Other comprehensive income (loss):
Foreign currency translation adjustments			(95	)			(6	)			(95	)			(17	)
Unrealized loss on investments			(7	)			2				(39	)			(1	)
Change in accumulated other comprehensive loss			(102	)			(4	)			(134	)			(18	)
Comprehensive loss		$	(1,404	)		$	(956	)		$	(5,193	)		$	(3,440	)

 

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

 

 

LOOKSMART, LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Nine Months Ended September 30,
		2014				2013
Cash flows from operating activities:
Net loss		$	(5,059	)		$	(3,422	)
Adjustment to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			1,032				173
Provision for doubtful accounts			25				155
Share-based compensation			5				37
Other non-cash charges			85				30
Deferred rent			(81	)			(34	)
Deferred lease incentive			58				58
Restructuring charge			23				40
Changes in operating assets and liabilities:
Trade accounts receivable			125				1,204
Prepaid expenses and other current assets			526				(879	)
Trade accounts payable			31				(541	)
Accrued liabilities			(74	)			(1,002	)
Deferred revenue and customer deposits			4				(134	)
Net cash used in operating activities			(3,300	)			(4,315	)
Cash flows from investing activities:
Purchase of investments			(76	)			(7,728	)
Proceeds from sale of investments			3,173				11,935
Payments for property and equipment			(1,025	)			(3,134	)
Purchase of intangible assets			-				(153	)
Net cash provided by investing activities			2,072				920
Cash flows from financing activities:
Principal payments of capital lease obligations			(134	)			(110	)
Proceeds from issuance of common stock			-				1
Payments for repurchase of common stock			(175	)			(18	)
Net cash used in financing activities			(309	)			(127	)
Effect of exchange rate changes on cash and cash equivalents			(95	)			(17	)
Decrease in cash and cash equivalents			(1,632	)			(3,539	)
Cash and cash equivalents, beginning of period			2,789				6,352
Cash and cash equivalents, end of period		$	1,157			$	2,813
Supplemental disclosure of cash flow information:
Interest paid		$	7			$	9
Income taxes paid		$	-			$	7
Supplemental disclosure of noncash activities:
Assets acquired through capital lease obligations		$	164			$	-
Change in unrealized gain (loss) on investments		$	(39	)		$	(1	)

 

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 engaged in three lines of business through Looksmart and its wholly owned subsidiaries, Clickable.com and Novatech.io. The Company operates each line of business, while being related to the others in terms of shared resources, as separate entities with their own core management, profits and losses, and the ability to operate independently as separate businesses. As a result, Management allows Looksmart to operate as a holding company and as an efficient capital allocator to each of the separate businesses with the desire to find mispriced assets in the public and private markets and take those assets to create scalable and sustainable businesses that can then be monetized for Looksmart’s shareholders.

 

Looksmart AdCenter

 

LookSmart, through its original “AdCenter” platform technology business, provides its customers with search, social, display, mobile and video advertising solutions as well as analytic, moderation and publishing workflow solutions across the entire social media marketing ecosystem. The customers of Looksmart range from small and medium-sized businesses to large Fortune 50 companies. LookSmart was organized in 1996 and is incorporated in the State of Delaware.

 

LookSmart's search advertising network generates advertisements that target search intent queries on Looksmart.com and partner publisher sites.  The network offers search advertising customers targeted search through a monitored search advertising distribution network using the Company’s “AdCenter” platform technology.  The advertisers that comprise the Company’s network include intermediaries, direct advertising customers and their agencies, as well as self-service customers in the United States and certain other countries.

 

Self-service advertisers are customers that sign-up directly online with the Company and pay by credit card. Direct advertisers (and their agencies) include customers whose main objective is to obtain conversions or sales from clicks. Intermediary customers do not directly advertise on our platform but sell into the affiliate networks of the large search engine providers (“Intermediaries”).

 

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

 

In addition, Looksmart, under its “Clickable” and “Syncapse ” brands, allows customers to manage paid, owned and earned media by providing a suite of solutions for social media marketers that include publishing, monitoring, data storage, compliance, management, ad placement and analytics.  The “Clickable Analytics” dashboard provides customers with the ability to easily put all their cross channel marketing (search, display, social, email, video, offline) and audience data from various sources into one unified, flexible and customizable platform.  The platform allows the customer to better understand and utilize the data for the customizing and layering of customer specific key performance indicators.  The Company believes that this platform will allow customers to combine data in a way that better suits their particular marketing, financial and operational goals both with standard and customized dashboards and analytics.  This platform allows companies to gather and manage Application Programming Interface (“API”) data from many data providers including Facebook, Twitter, YouTube, and Instagram, as well as analyze such data in the “Clickable” proprietary platform and within a company’s own data warehouse.

 

Further, LookSmart 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.

 

Lastly, starting in the fourth quarter of 2013, the Company began to offer a LookSmart-branded search engine.  For parties submitting search queries, the Company offers free-of-charge search results ranked and presented based on proprietary algorithms.   While early in its evolution, part of the Company's current search engine monetization strategy is to generate sponsored search results as a part of overall search results and provide links to paying advertisers’ websites.

 

In March 2014, the company formed a joint venture, Conversion Media Holdings, LLC, a Delaware limited liability corporation, to create content sites directed at ecommerce verticals like housewares, electronics and other consumer products.   The operations began in April of 2014 and currently are in a testing phase. The Company believes that this joint venture will begin to contribute revenue at the end the 4^th quarter of 2014.

 

 

 

Clickable.com

 

Clickable helps brands and agencies measure marketing ROI through customer lifetime by connecting critical marketing and advertising products and services into one platform that gives customers the ability to analyze, publish, moderate, social media and search marketing. Clickable also offers its platform as a white label solution to agencies who use it to save hours of time creating reports, increase transparency to clients, increase stickiness of clients, increase recurring revenue streams, and upsell other tools and services. The Company has begun to work with large international brands to assist them in creating, maintaining and analyzing their social media presence online. The Company’s goal is to partner with social media companies such as Facebook, Twitter, Pinterest and YouTube, as well as others, to offer customers the ability to maximize their ad spend in all relevant ad categories.

 

In September 2013, LookSmart purchased the assets related to its Syncapse Inc. (“Syncapse") technology for $3 million from MNP Ltd., a receiver appointed by Ontario Superior Court of Justice under an appointment order.  As a result of this transaction, the Company acquired a social media platform that the Company believes has allowed it to quickly scale into social media analytics, publishing, and moderation. This, in turn, should allow our enterprise customers the ability to publish, monitor and analyze their social media presence on paid, owned and earned media.  .     

 

Novatech.io

 

In November of 2013, LookSmart acquired an approximate 10,000 square foot Data Center facility in Phoenix, Arizona.  Looksmart has completed the process of consolidating its cloud services in the newly occupied and wholly owned secure Data Center.  As a result, the Company intends to expand its cloud-based offerings to its customers.

 

NovaTech's cloud based services include a private cloud ecosystem comprised of multi-vendor enterprise technologies and capabilities while serving as a production research and development environment to support the needs of companies who need to scale their information technology operations quickly and securely.

 

Principles of Consolidation

 

The Unaudited Consolidated Financial Statements as of September 30, 2014 and December 31, 2013, and for the three and nine months ended September 30, 2014 and 2013, 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 September 30, 2014, and for the three and nine months ended September 30, 2014 and 2013, 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 September 30, 2014 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, 2013 (“Annual Report”). The Consolidated Balance Sheet as of December 31, 2013 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States (“GAAP”) for complete financial statements. The results of operations for the interim period ended September 30, 2014 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.

 

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 in the Unaudited Consolidated Statements of Comprehensive Loss. 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

 

Our online search advertising revenue is composed of per-click fees that we charge customers and profit sharing arrangements we enter with Intermediaries. The per-click fee charged for keyword-targeted listings is calculated based on the results of online bidding for keywords or page content, up to a maximum cost per keyword or page content set by the customer. The Company has profit-sharing agreements with several customers that call for the sharing of profits and losses. Profit sharing arrangements are governed by contractual agreements. Revenue from these profit-sharing agreements is reported net of the customer’s share of profit.

 

Revenue also includes revenue share from licensing of private-labeled versions of our 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. We pay 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 we are the primary obligors to the advertisers who are the customers of the advertising service.

 

We also enter into agreements to provide private-labeled versions of our products, including licenses to the 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; minimum monthly fees; and other license fees. We recognize 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.

 

We provide 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 revenue allowance included in trade receivables, net is insignificant at both September 30, 2014 and December 31, 2013.

 

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.

 

The Company evaluates individual arrangements with customers to make a determination under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605-45 Revenue Recognition. We test and record revenue accordingly.

 

 

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. The review is based on factors including the application of historical collection rates to current receivables and economic conditions. Additional allowances for doubtful accounts are considered and recorded 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 $0.7 million at both September 30, 2014 and December 31, 2013. Bad debt expense included in general and administrative expense was insignificant for both the three and nine months ended September 30, 2014. Bad debt expense included in general and administrative expense was not significant and $0.2 million for the three and nine months ended September 30, 2013, respectively.

 

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 September 30, 2014 and December 31, 2013, 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. The Company also invests in fully collateralized funds with maturities of less than two years. These amounts exceed federally insured limits at September 30, 2014 and December 31, 2013. 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.

 

The following table reflects customers that accounted for more than 10% of net accounts receivable:

 

		September 30,				December 31,
		2014				2013
Company 1			13	%			**
Company 2			11	%			**
Company 3			12	%			**
Company 4			11	%			**
Company 5			**				22	%
Company 6			**				18	%
Company 7			**				16	%

 

** Less than 10%

 

Revenue and Cost Concentrations

 

The following table reflects the concentration of revenue by geographic locations that accounted for more than 10% of net revenue:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
United States			85	%			48	%			90	%			67	%
Europe, Middle East and Africa			**				22	%			**				18	%

 

** 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 September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
Advertiser Networks			92	%			85	%			91	%			86	%
Publisher Solutions			8	%			15	%			9	%			14	%

 

The following table reflects the percentage of revenue attributed to customers who accounted for more than 10% of net revenue, all of which are Intermediaries:

 

Three Months Ended September 30,

Nine Months Ended September 30,

2014

2013

2014

2013

Company 1

**

**

10

%

**

Company 2

11

%

**

11

%

**

Company 3

**

**

**

**

Company 4

**

**

**

**

 

** 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 total TAC:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
Distribution Partner 1			15	%			**				16	%			**
Distribution Partner 2			10	%			**				13	%			**
Distribution Partner 3			22	%			13	%			21	%			31	%
Distribution Partner 4			**				**				**				12	%
Distribution Partner 5			**				**				**				11	%

 

** Less than 10%

 

Property and Equipment

 

Property and equipment are stated at cost, except when an impairment analysis requires the use of fair value, 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
Building		39 years

 

Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the lease term.

 

When assets are retired or otherwise disposed of, the cost and accumulated depreciation and amortization are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in operating expenses. Maintenance and repairs are charged to expense as incurred. Expenditures that substantially increase an asset’s useful life are capitalized.

 

In the fourth quarter of 2013, the Company acquired a 10,000 square foot Data Center facility in Phoenix, Arizona. This facility has allowed the Company to consolidate its data needs in a company-owned Data Center, and should allow for the expansion of its cloud-based offerings to its customers.

 

 

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. These costs are capitalized after certain milestones have been achieved and generally amortized over a three-year period once the project is placed in service.

 

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 three years. The Company expects to continue to invest in internally developed software and to capitalize such costs in the future, although no such costs were capitalized in the three and nine months ended September 30, 2014.

 

Restructuring Charges

 

In August 2012, the Company entered into an agreement to sublease its office space in San Francisco under terms generally equivalent to its existing commitment. This lease ends on December 31^, 2014, at which time the company has no longer any obligations under the terms of this lease.

 

Impairment of Long-Lived Assets

 

The Company reviews long-lived assets held or used in operations, including property and equipment and internally developed software, for impairment in accordance with ASC 360-10 “Impairment and Disposal of Long-Lived Assets”.

 

The Company reviews assets for evidence of impairment annually at year-end and whenever events or changes in circumstances indicate the carrying values may not be recoverable. The impairment review requires the Company to make significant estimates about its future performance and cash flows, as well as other assumptions. These estimates can be affected by numerous factors, including changes in economic, industry or market conditions, changes in business operations and changes in competition.

 

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.

 

TAC expense is recorded in cost of revenue.

 

Share-Based Compensation

 

The Company recognizes share-based compensation costs for all share-based payment transactions with employees, including grants of employee stock options, restricted stock awards, and employee stock purchases related to the Employee Stock Purchase Plan, over the requisite service period based on their relative fair values. We estimate the fair value of each option award on the date of grant using the Black-Scholes option valuation model. Our assumptions about stock-price volatility are based on the actual volatility of our publicly traded stock. The risk-free interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of the grant. We estimate the expected term based upon the historical exercise activity. The value of the portion of the award that is ultimately expected to vest is recognized as expense in the Company’s Consolidated Statements of Operations over the requisite service periods. Share-based compensation expense, related to stock option grants and employee stock purchases, recognized were not significant for both the three and nine months ended September 30, 2014, as well as both the three and nine months ended September 30, 2013.

 

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.

 

The Company elected to adopt the alternative transition method for calculating the tax effects of share-based compensation to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee share-based compensation awards.

 

 

Advertising Costs

 

Advertising costs are charged to sales and marketing expenses as incurred and were insignificant and $0.03 in the three and nine months ended September 30, 2014, respectively. Advertising costs were insignificant in both the three and nine months ended September 30, 2013.

 

Product Development Costs

 

Research of new product ideas and enhancements to existing products are charged to expense as incurred.

 

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 potential accrued interest and penalties related to unrecognized tax benefits within operations as income tax expense.

 

Comprehensive Loss

 

Other comprehensive loss as of September 30, 2014 and December 31, 2013, consists of unrealized gains and losses on marketable securities categorized as available-for-sale and foreign currency translation adjustments.

 

Net Loss per Common Share

 

Basic net loss per share is calculated using the weighted average shares of common stock outstanding, excluding treasury stock. Diluted net loss per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding, excluding treasury stock, during the period, using the treasury stock method for stock options. As a result of the Company’s net loss position at both September 30, 2014 and 2013, there is no dilution.

 

Segment Information

 

The Company has one operating segment, online advertising. While the Company operates under one operating segment, management reviews revenue under two product offerings—Advertiser Networks and Publisher Solutions.

 

As of September 30, 2014 and December 31, 2013, the Company’s accounts receivable and deferred revenue are primarily related to the online advertising segment. All long-lived assets are located in the United States and Canada.

 

Adoption of New Accounting Standards

 

On January 2, 2014 we adopted guidance issued by the Financial Accounting Standards Board (“FASB”), ASU 2013-04, “Liabilities – Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date”, an amendment providing guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. Adoption of this new guidance had no impact on the Company’s consolidated financial position or results of operations.

 

Recent Accounting Pronouncements

 

In April 2014, the FASB issued Accounting Standards Update No. 2014-08 (“ASU 2014-08”) “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." ASU 2014-08 raises the threshold for a disposal to qualify as a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. It is effective for annual periods beginning on or after December 15, 2014. Early adoption is permitted but only for disposals that have not been reported in financial statements previously issued. We do not expect the impact of the adoption of ASU 2014-08 to be material to our consolidated financial statements.

 

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (“ASU 2014-09”) "Revenue from Contracts with Customers." ASU 2014-09 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)”, and requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. We are currently in the process of evaluating the impact of the adoption of ASU 2014-09 on our consolidated financial statements.

 

2. Cash and Available for Sale Securities

 

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 September 30, 2014, and December 31, 2013 (in thousands):

 

		Amortized Cost and Estimated Fair Value
		September 30,				December 31,
		2014				2013
Cash and cash equivalents:
Cash		$	698			$	1,048
Cash equivalents
Money market mutual funds			459				1,641
Commercial paper			-				100
Total cash equivalents			459				1,741
Total cash and cash equivalents			1,157				2,789
Short-term investments:
Corporate bonds			-				501
Certificates of deposit			123				800
Commercial paper			-				500
Other commodities			35				-
Collateralized debt obligations			-				1,301
Total short-term investments			158				3,102
Long-term investments:
Certificates of deposit			-				154
Total long-term investments			-				154
Total cash, and cash equivalents, short-term and long-term investments		$	1,315			$	6,045

 

Realized gains and losses were not significant for either of the three and nine months ended September 30, 2014 and 2013. As of September 30, 2014, and December 31, 2013, unrealized gains or losses on investments were $0.03 and insignificant, respectively. The cost of all securities sold is based on the specific identification method.

 

The contractual maturities of cash equivalents and short-term investments at September 30, 2014, and December 31, 2013, were less than one year. There were no long-term investments at September 30, 2014. The contractual maturity of long-term investments was just over one year as of December 31, 2013.

 

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 nine months ended September 30, 2014 and 2013, the Company did not recognize any impairment charges on outstanding investments. As of September 30, 2014, the Company does not consider any of its investments to be other-than-temporarily impaired.

 

 

3. Property and Equipment

 

Property and equipment consist of the following at September 30, 2014, and December 31, 2013 (in thousands):

 

		September 30, 2014												December 31, 2013
		Cost				Accumulated Depreciation				Net Book Value				Cost				Accumulated Depreciation				Net Book Value
Computer equipment		$	1,113			$	(542	)		$	571			$	490			$	(244	)		$	246
Furniture and fixtures			22				(3	)			19				21				(1	)			20
Software			2,848				(948	)			1,900				2,962				(246	)			2,716
Leasehold improvements			73				(16	)			57				59				(4	)			55
Land and Buildings			1,339				(21	)			1,318				797				(3	)			794
Total		$	5,395			$	(1,530	)		$	3,865			$	4,329			$	(498	)		$	3,831

 

Depreciation expense on property and equipment for the three and nine months ended September 30, 2014, including property and equipment under capital lease at September 30, 2014, was $0.3 million and $1.1 million, respectively, and is recorded in operating expenses. Depreciation expense on property and equipment for the three and nine months ended September 30, 2013, was $0.06 million and $0.2 million, respectively, and is recorded in operating expenses. Equipment under capital lease at September 30, 2014 totaled $0.2 million. There was no equipment under capital lease at September 30, 2013.

 

In November of 2013, LookSmart acquired an approximate 10,000 square foot Data Center facility in Phoenix, Arizona.  By the end of November 2013, LookSmart completed the process of consolidating its cloud services into this Data Center. As a result, the Company intends to expand its cloud based offerings to its customers.

 

4. Other Assets

 

The Company’s other assets are as follows at September 30, 2014, and December 31, 2013 (in thousands):

 

		September 30, 2014												December 31, 2013
		Gross Amount				Accumulated Amortization				Net Book Value				Gross Amount				Accumulated Amortization				Net Book Value
Other assets			85				-				85				87				-				87
Total		$	85			$	-			$	85			$	87			$	-			$	87

 

5. Accrued Liabilities

 

Accrued liabilities consisted of the following as of September 30, 2014, and December 31, 2013 (in thousands):

 

		September 30,				December 31,
		2014				2013
Accrued distribution and partner costs		$	158			$	176
Accrued compensation and related expenses			100				87
Accrued professional service fees			97				146
Other			5				35
Total accrued liabilities		$	360			$	444

 

6. Restructuring Charges

 

In August 2012, the Company entered into an agreement to sublease its office space in San Francisco under terms generally equivalent to its existing commitment. This lease ends on December 31^, 2014, at which time the company has no longer any obligations under the terms of this lease.

 

 

7. Capital Lease and Other Obligations

 

Capital lease and other obligations consist of the following at September 30, 2014, and December 31, 2013 (in thousands):

 

		September 30,				December 31,
		2014				2013
Capital lease obligations		$	39			$	-
Deferred rent			105				186
Total capital lease and other obligations			144				186
Less: current portion of capital lease obligations			(39	)			-
Capital lease and other obligations, net of current portion		$	105			$	186

 

Refer to Note 8 for future minimum payment details.

 

Capital Lease Obligations

 

City National Bank

 

We have an outstanding standby letter of credit issued by City National Bank (“CNB”) of approximately $0.1 and $0.2 million at September 30, 2014 and December 31, 2013, respectively, related to security of the subleased corporate office lease and secured by a money market account held at CNB.

 

8. Commitments and Contingencies

 

As of September 30, 2014, future minimum net payments under all operating leases are as follows (in thousands):

 

		Capital Lease				Operating Leases				Total
Three months ending December 31, 2014		$	41			$	38			$	79
Years ending December 31,
2015			-				81				81
2016			-				-				-
2017			-				-				-
2018			-				-				-
Total minimum net payments		$	41			$	119			$	160
Less: amount representing interest			(2	)
Present value of net minimum payments			39
Less: current portion			(39	)
Long-term portion of capital lease obligations		$	-

 

Operating Leases

 

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 July 2012, the Company entered into an agreement to sublease this subleased office space under terms generally equivalent to its existing commitment for a term that commenced in August 2012 and expires in December 2014.

 

In August 2013, the Company leased office space of approximately 2,341 square feet for its corporate office in San Francisco, California under a five year lease that commenced in September 2014 and expires on August 31, 2018. On October 15, 2014, the Company terminated this lease, closed the office and was released from all obligations under this lease.

 

The Company leases office space in Los Angeles, California of approximately of 4,803 square feet. The lease expires in July 2015.

 

 

The Company entered into a 30-month operating lease agreement for various network operating equipment beginning in the fourth quarter of 2013.

 

Rent expense under all operating leases was $0.04 million and $0.1 million for the three and nine months ended September 30, 2014, respectively. Rent expense under all operating leases was $0.04 and $0.1 million for the three and nine months ended September 30, 2013, respectively.

 

Letters of Credit

 

We have an outstanding standby letter of credit issued by CNB of approximately $0.1 million at September 30, 2014, related to security of the subleased corporate office lease and secured by a restricted money market account held at CNB.

 

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 various lessors 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

 

On September 4, 2013, Cowen and Company, LLC filed a complaint against LookSmart with the Superior Court of California for the County of San Francisco. According to the complaint, Cowen claims that LookSmart is required by an engagement letter dated August 14, 2009 to pay Cowen a $1,000,000 "Sale Transaction Fee" as a result of the third-party tender offer for LookSmart Ltd. consummated by PEEK Investments LLC on January 14, 2013. The parties agreed to a $450,000 settlement at a June 10, 2014 mediation. This amount was subsequently paid by the Company on July 11, 2014. The Complaint and Counter Claim was dismissed with prejudice on August 27, 2014.

 

On October 3, 2013, WeBoost Media S.R.L., a Societa responsabilita ("WeBoost") filed a complaint against LookSmart with the Superior Court of California for the County of San Francisco. The matter was subsequently removed and is currently pending before the United States District Court, Northern District of California. WeBoost’s complaint asserts claims for breach of contract and extra-contractual tort and punitive damages related to "click fraud".  No specific monetary amounts are indicated in the complaint. LookSmart believes the claims are meritless and continues to vigorously defend the matter. The Company is unable to presently determine the risk of loss associated with this matter.

 

The Company is involved, from time to time, in various other 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.

 

 

9. Stockholders’ Equity

 

Share-Based Compensation

 

Stock Option Plans

 

In December 1997, the Company approved the 1998 Stock Option Plan (the “1998 Plan”). In June 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 two plans (collectively, the “Plans”).

 

The Compensation Committee of the Board of Directors administers the Company’s Plans. Awards under the Plans principally include at-the-money options and fully vested restricted stock. Outstanding stock options generally become exercisable over a four-year period from the grant date and have a term of seven years. Grants can only be made under the 2007 Plan. The 1998 Plan is closed to further share issuance and all options have expired or been forfeited as of September 30, 2013. The number of shares issued or reserved for issuance under the 2007 Plan was 1.2 million and 1.4 million shares of common stock as of September 30, 2014 and December 31, 2013, respectively. There were 1.2 million shares available to be granted under the 2007 Plan at September 30, 2014.

 

Share-based compensation expense recorded during three and nine months ended September 30, 2014, and 2013 was included in the Company’s Unaudited Consolidated Statements of Operations as follows (in thousands):

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
Sales and marketing		$	-			$	-			$	1			$	2
Product development and technical operations			-				1				1				6
General and administrative			1				2				3				31
Total share-based compensation expense		$	1			$	3			$	5			$	39

 

Total unrecognized share-based compensation expense related to share-based compensation arrangements at September 30, 2014 was not signficantand is expected to be recognized over a weighted-average period of approximately 0.72 years. The total fair value of equity awards vested during both the three and nine months ended September 30, 2014, was not significant. The total fair value of equity awards vested during both the three and nine months ended September 30, 2013, was not signficant.

 

 

Option Awards

 

Stock option activity under the Plans during the three and nine months ended September 30, 2014 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, 2013			25			$	4.16				4.67			$	-
Granted			-				-
Exercised			-				-
Expired			-				-
Forfeited			(6	)			3.03
Options outstanding at March 31, 2014			19			$	4.50				4.23				-
Granted			-				-
Exercised			-				-
Expired			-				-
Forfeited			(7	)			1.85
Options outstanding at June 30, 2014			12			$	5.13				3.57				-
Granted			-				-
Exercised			-				-
Expired			-				-
Forfeited			(7	)			1.88
Options outstanding at September 30, 2014			5			$	5.27				3.18			$	-
Vested and expected to vest at September 30, 2014			4			$	5.33				0.68			$	-
Exercisable at September 30, 2014			4			$	5.49				0.57			$	-

 

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 quarter-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 September 30, 2014:

 

								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)
$	4.14		-	$	5.64				4				3.80			$	4.53				3			$	4.59
	8.10		-		8.10				1				0.80				8.10				1				8.10
									5				3.18				5.27				4				5.49

 

Stock Awards

 

The Company did not issue restricted stock during the three and nine months ended September 30, 2014 and 2013.

 

Employee Stock Purchase Plan

 

On July 14, 2009, the 2009 Employee Stock Purchase Plan (the “2009 ESPP”) was approved by the shareholders and authorized to issue up to 500 thousand shares of Common Stock to employees. Substantially all employees may purchase the Company’s common stock through payroll deductions at 85 percent of the lower of the fair market value at the beginning or end of the offering period. Each offering and purchase period is six months. ESPP contributions are limited to a maximum of 15% 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 for the 2009 ESPP was zero in the three and nine months ended September 30, 2014 and insignificant in the three and nine months ended September 30, 2013. As of September 30, 2014, 28 thousand shares (adjusted for the 3:1 reverse split in November 2013) have been issued under the 2009 Plan. Following the February 15, 2013 purchase, the ESPP was suspended pending a review by the Company’s Board of Directors of all equity incentive arrangements.

 

Share-Based Compensation Valuation Assumptions

 

We estimate the fair value of each option award on the date of grant using the Black-Scholes option valuation model. Our assumptions about stock-price volatility are based on the actual volatility of our publically traded stock. The risk-free interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of the grant. We estimate the expected term based upon the historical exercise activity.

 

No options were granted in the first nine months of 2014 or 2013, therefore no weighted average assumptions are included here.

 

Share-based compensation expense recognized in the Consolidated Statements of Operations is based on awards ultimately expected to vest and 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 and Director Stock Options and Purchase Plans

 

There were no options exercised in both the three and nine months ended September 30, 2014 and 2013. The Company issues new shares of common stock upon exercise of stock options. No income tax benefits have been realized from exercised stock options.

 

Repurchase of Equity Securities by the Company

 

In May 2012, the Company's Board of Directors authorized the repurchase of up to $1 million of the Company's common shares. Under the program, the Company may purchase its common shares from time to time in the open market or in privately negotiated transactions.

 

Approximately 54 thousand shares were purchased during the three months ended September 30, 2014, at an average price of $1.70per share under the program and recorded as Treasury Stock at cost totaling approximately $92 thousand dollars. Approximately 13 thousand shares were purchased at an average price of $2.01 per share under the program in the year ended December 31, 2013, and recorded as Treasury Stock at cost totaling approximately $26 thousand dollars.

 

10. 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 September 30, 2014, and December 31, 2013 were as follows (in thousands):

 

		Balance at  September 30, 2014				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobserved Inputs (Level 3)
Cash equivalents:
Money market mutual funds		$	459			$	459			$	-			$	-
Commercial paper			0				-				-				-
Total cash equivalents			459				459				-				-
Short-term investments:
Certificates of deposit			123				-				123				-
Other commodities			35				-				35				-
Commercial paper			0				-				-				-
Collateralized debt securities			0				-				-				320
Total short-term investments			158				-				158				320
Total financial assets measured at fair value		$	617			$	459			$	158			$	320

 

 

		Balance at  December 31, 2013				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobserved Inputs (Level 3)
Cash equivalents:
Money market mutual funds		$	1,641			$	1,641			$	-			$	-
Commercial paper			100				-				100				-
Total cash equivalents			1,741				1,641				100				-
Short-term investments:
Certificates of deposit			800				-				800				-
Corporate bonds			501				-				501				-
Commercial paper			500				-				500				-
Collateralized debt securities			1,301				-				-				1,301
Total short-term investments			3,102				-				1,801				1,301
Long-term investments:
Certificates of deposit			154				-				154				-
Total long-term investments			154				-				154				-
Total financial assets measured at fair value		$	4,997			$	1,641			$	2,055			$	1,301

 

The Company held no Level 3 investments at September 30, 2014. The Company held approximately $1.3 million in Level 3 investments at December 31, 2013.

 

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 September 30, 2014 and December 31, 2013, the Company did not adjust prices received from the pricing service.

 

On June 1, 2013 the Company invested approximately $2.0 million in a fully collateralized fund with a maturity date of September 30, 2014.  The investment generally entitles the Company to monthly payments of principal and interest, subject to certain restrictions. From inception through September 30, 2014, the Company has received payments of $2.3 million, comprised of $2.0 million in principal and $0.3 million in interest.  The investment is recorded at amortized cost, reduced for non-temporary losses charged to earnings. No non-temporary losses were recognized by the Company as of and for the periods since the date of investment.  As of September 30, 2014, and December 31, 2013, the aggregate fair value of the investment was zero and approximately $1.3 million, respectively. 

 

 

Level 3 Assets – Roll forward (in thousands):

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Collateralized Debt Securities
Balance at December 31, 2013		$	1,301
Transfers into Level 3			-
Transfers out of Level 3			-
Total gains or losses
Included in earnings (or changes in net assets)			47
Included in Other comprehensive income			-
Purchases, issuances, sales, and settlements
Purchases			-
Issuances			-
Sales			-
Settlements			(541	)
Balance at March 31, 2014		$	807
Transfers into Level 3			-
Transfers out of Level 3			-
Total gains or losses
Included in earnings (or changes in net assets)			26
Included in Other comprehensive income			-
Purchases, issuances, sales, and settlements
Purchases			-
Issuances			-
Sales			-
Settlements			(513	)
Balance at June 30, 2014		$	320
Transfers into Level 3			-
Transfers out of Level 3			-
Total gains or losses
Included in earnings (or changes in net assets)			7
Included in Other comprehensive income			-
Purchases, issuances, sales, and settlements
Purchases			-
Issuances			-
Sales			-
Settlements			(327	)
Balance at Sep 30, 2014			-

 

Trade accounts receivable, net: The carrying value reported in the Consolidated Balance Sheets approximates fair value and 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 Consolidated Balance Sheets for these items approximates their fair value, which is the likely amount that the liability with short settlement periods would be transferred to a market participant with a similar credit standing as the Company.

 

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, adequate liquidity to fund our operations and meet our other cash requirements, are inherently uncertain as they are based on our expectations and assumptions concerning future events. These forward-looking statements are subject to numerous known and unknown risks and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including but not limited to, the possibility that we may fail to maintain or grow our listings advertiser base and/or distribution network, that existing and potential distribution partners may opt to work with, or favor the products of, competitors if our competitors offer more favorable products or pricing terms, that we may be unable to grow our online search advertising revenue and/or find alternative sources of revenue, that we may be unable to attain or maintain customer acceptance of our publisher solutions products, that changes in the distribution network composition may lead to decreases in query volumes, that we may be unable to maintain or improve our query volume, match rate, number of paid clicks, average revenue per click, conversion rate or other ad network metrics, that we may be unable to achieve or maintain profitability, that we may be unable to retain our existing credit facilities or obtain new credit facilities, that we may be unable to attract and retain key personnel, that we may have unexpected increases in costs and expenses, that we may be unable to remain listed on the NASDAQ Stock Market, or that one or more of the other risks described elsewhere in this report may occur.

 

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

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are discussed in our Annual Report on Form 10-K for the year ended December 31, 2013. As of September 30, 2014, there had been no material changes to our critical accounting policies and estimates.

 

Business Overview

 

For a description of our business, please refer to Note 1.

 

 

Results of Operations

 

Overview of the Three and Nine Months Ended September 30, 2014 and 2013

 

The following tables set forth selected information concerning our results of operations as a percentage of consolidated net revenue for the periods indicated (in thousands):

 

		Three Months Ended September 30,
		2014				% of Revenue				2013				% of Revenue				Dollar Change				% Change
Revenue		$	1,311				100.0	%		$	1,642				100.0	%		$	(331	)			(20	)%
Cost of revenue			648				49.4	%			1,129				68.8	%			(481	)			(43	)%
Gross profit			663				50.6	%			513				31.2	%			150				29	%
Operating expenses:
Sales and marketing			398				30.4	%			264				16.1	%			134				51	%
Product development and technical operations			1,180				90.0	%			830				50.5	%			350				42	%
General and administrative			472				36.0	%			422				25.7	%			50				12	%
Restructuring charge			7				0.5	%			9				0.6	%			(2	)			-
Total operating expenses			2,057				156.9	%			1,525				92.9	%			532				35	%
Income loss from operations			(1,394	)			(106.3	)%			(1,012	)			(61.7	)%			(382	)			38	%
Non-operating income (expense), net			92				7.0	%			67				4.1	%			25				37	%
Loss from operations before income taxes			(1,302	)			(99.3	)%			(945	)			(57.6	)%			(357	)			38	%
Income tax expense			-				-				(7	)			(0.4	)%			7				-
Net loss		$	(1,302	)			(99.3	)%		$	(952	)			(58.0	)%		$	(350	)			37	%

 

		Nine Months Ended September 30,
		2014				% of Revenue				2013				% of Revenue				Dollar Change				% Change
Revenue		$	3,779				100.0	%		$	5,188				100.0	%		$	(1,409	)			(27	)%
Cost of revenue			2,038				53.9	%			3,487				67.2	%			(1,449	)			(42	)%
Gross profit			1,741				46.1	%			1,701				32.8	%			40				2	%
Operating expenses:
Sales and marketing			1,243				32.9	%			550				10.6	%			693				126	%
Product development and technical operations			3,597				95.2	%			2,230				43.0	%			1,367				61	%
General and administrative			2,113				55.9	%			2,413				46.5	%			(300	)			(12	)%
Restructuring charge			23				0.7	%			31				0.6	%			(8	)			(26	)%
Total operating expenses			6,976				184.6	%			5,224				100.7	%			1,752				34	%
Loss from operations			(5,235	)			(138.5	)%			(3,523	)			(67.9	)%			(1,712	)			49	%
Non-operating income (expense), net			176				4.7	%			108				2.1	%			68				63	%
Loss from continuing operations before income taxes			(5,059	)			(133.9	)%			(3,415	)			(65.8	)%			(1,644	)			48	%
Income tax expense			-				-				(7	)			(0.1	)%			7				-
Net loss		$	(5,059	)			(133.9	)%		$	(3,422	)			(65.9	)%		$	(1,637	)			48	%

 

Revenue

 

Revenue is derived from two service offerings or “products” of LookSmart Ltd. (the “Company”): Advertiser Networks and Publisher Solutions. Total revenue and revenue from Advertiser Networks and Publisher Solutions for the three and nine months ended September 30, 2014, and 2013, was as follows (in thousands):

 

		Three Months Ended September 30,
		2014				% of Revenue				2013				% of Revenue				Dollar Change				% Change
Advertiser Networks		$	1,205				92	%		$	1,398				85	%		$	(193	)			(14	)%
Publisher Solutions			106				8	%			244				15	%			(138	)			(57	)%
Total revenue		$	1,311				100	%		$	1,642				100	%		$	(331	)			(20	)%

 

 

		Nine Months Ended September 30,
		2014				% of Revenue				2013				% of Revenue				Dollar Change				% Change
Advertiser Networks		$	3,456				91	%		$	4,439				86	%		$	(983	)			(22	)%
Publisher Solutions			323				9	%			749				14	%			(426	)			(57	)%
Total revenue		$	3,779				100	%		$	5,188				100	%		$	(1,409	)			(27	)%

 

Advertiser Networks

 

The decrease in Advertiser Networks revenue for the three and nine months ended September 30, 2014, as compared to the same period in 2013 is the result of a reduction in revenues from all categories, Intermediaries, Direct Advertisers and Self Service Advertisers.

 

In the nine months of 2014, revenue from Intermediaries decreased compared to the nine months of 2013. We experienced a continuing decrease in Advertising Network revenue in the nine months of 2014 following a trend that began in late 2011.

 

In the nine months of 2014, revenue from Direct Advertisers decreased compared to the nine months of 2013.

 

In the nine months of 2014, revenue from Self Service Advertisers decreased compared to the nine months of 2013. The Company plans to invest in the Self Service Platform in the future.

 

Publisher Solutions

 

Publisher Solutions revenues decreased in the three and nine months ended September 30, 2014, compared to the same period in 2013 generally due to volume reductions by licensees.

 

Cost of Revenue and Gross Profit

 

Cost of revenue is primarily TAC (costs paid to our distribution network partners). Other costs include data center rent and power usage and credit card fees.

 

Cost of revenue for the three and nine months ended September 30, 2014 and 2013 were as follows (in thousands):

 

		Three Months Ended September 30,
		2014				% of Revenue				2013				% of Revenue				Dollar Change				% Change
Traffic acquisition costs		$	510				39	%		$	608				37	%		$	(98	)			(16	)%
Other costs			189				15	%			521				32	%			(332	)			(64	)%
Total cost of revenue		$	699				54	%		$	1,129				69	%		$	(430	)			(38	)%
Traffic acquisition costs as percentage of Advertiser Network revenue							42	%							43	%

 

		Nine Months Ended September 30,
		2014				% of Revenue				2013				% of Revenue				Dollar Change				% Change
Traffic acquisition costs		$	1,481				39	%		$	2,193				42	%		$	(712	)			(32	)%
Other costs			557				15	%			1,294				25	%			(737	)			(57	)%
Total cost of revenue		$	2,038				54	%		$	3,487				67	%		$	(1,449	)			(42	)%
Traffic acquisition costs as percentage of Advertiser Network revenue							43	%							49	%

 

TAC decreased in the three and nine months ended September 30, 2014, when compared to the three and nine months ended September 30, 2013. Our Intermediary category of revenue generally has lower margins than Direct and Self-Service and the change in revenue mix from 2013 to 2014 drove the margin decline.

 

 

Certain other costs, such as data center costs and power usage, are generally fixed costs. Total cost of revenue decreased in 2014 primarily as result of decreases of TAC combined with decreases in other costs in the current year.

 

TAC as a percentage of Advertiser Network revenue decreased to 39% in the nine months eded September 30, 2014, as compared to 42% in the same period in 2013 as a result of overall revenue mix changes from 2013 to 2014.

 

Operating Expenses

 

Operating expenses for the three and nine months ended September 30, 2014, as compared to the same period in 2013, increased by $0.5 million and $1.7 million, respectively. Contributing factors included increases in product and development costs, and depreciation.

 

Operating expenses consist of sales and marketing, product development and technical operations, general and administrative, and restructuring charges for the three and nine months ended September 30, 2014, and 2013, and were as follows (in thousands):

 

		Three Months Ended September 30,
		2014				% of Revenue				2013				% of Revenue				Dollar Change				% Change
Sales and marketing		$	398				30	%		$	264				16	%		$	134				51	%
Product development and technical operations			1,180				90	%			830				50	%			350				42	%
General and administrative			472				36	%			422				26	%			50				12	%
Restructuring charge			7				0				9				1	%			(2	)			(0	)
Total operating expenses		$	2,057				157	%		$	1,525				93	%		$	532				35	%

 

		Nine Months Ended September 30,
		2014				% of Revenue				2013				% of Revenue				Dollar Change				% Change
Sales and marketing		$	1,243				33	%		$	550				11	%		$	693				126	%
Product development and technical operations			3,597				95	%			2,230				43	%			1,367				61	%
General and administrative			2,113				56	%			2,413				46	%			(300	)			(12	)%
Restructuring charge			23				1	%			31				1	%			(8	)			(26	)%
Total operating expenses		$	6,976				185	%		$	5,224				101	%		$	1,752				34	%

 

Sales and Marketing

 

Sales and marketing expenses in the current year include salaries, share-based compensation and other costs of employment for our sales force, sales administration and customer service staff and marketing personnel, overhead, facilities and allocation of depreciation. Sales and marketing expenses also include the costs of advertising, trade shows, public relations activities and various other activities supporting our customer acquisition effort.

 

The increase in sales and marketing expenses for the three and nine months ended September 30, 2014, reflects a rebuilding effort in our sales force. The Company is developing plans for sales and marketing and higher expenses in the future are expected in this functional area.

 

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 and the Clickable.com 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. "The Clickable.com Platform is used to provide customers with analytics, publishing, social and search advertising business intelligence, as well as incorporating customer and partner data using API's and custom data integration to manage their marketing return on investment."  These costs include salaries and associated costs of employment, including share-based compensation, overhead, and facilities. 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.    

 

 

Beginning in 2013, the company had made a concentrated effort to rebuild product and technical human resources by increasing the Company’s product and technical resources to a level that the Company feels appropriate for its current and expected businesses.

 

General and Administrative

 

General and administrative expenses include personnel cost, legal, insurance, tax and accounting, consulting, professional services fees and the provision for, and reductions of, the allowance for doubtful trade receivables.

 

Operating expense for the three and nine months ended September 30, 2014, included $0.5 million related to the settlement of the legal claim by Cowen. Operating expense for the three and nine months ended September 30, 2013, included $0.5 million related to the tender offer by PEEK. We do not expect substantial future increases in general and administrative expense.

 

Other Items

 

The tables below set forth other continuing operations data for the three and nine months ended September 30, 2014, and 2013 (in thousands):

		Three Months Ended September 30,
		2014				% of Revenue				2013				% of Revenue				Dollar Change				% Change
Non-operating income (expense), net
Interest income		$	7				1	%		$	87				5	%		$	(80	)			(92	)%
Interest expense			-				-				-				-				-				100	%
Other income, net			85				6	%			(20	)			(1	)%			105				(525	)%
Total non-operating income (expense), net		$	92				7	%		$	67				4	%		$	25				37	%
Income tax expense		$	-				-			$	(7	)			-			$	7				(100	)%

 

		Nine Months Ended September 30,
		2014				% of Revenue				2013				% of Revenue				Dollar Change				% Change
Non-operating income (expense), net
Interest income		$	81				2	%		$	128				2	%		$	(47	)			(37	)%
Interest expense			(7	)			-				(9	)			-				2				(22	)%
Other income (expense), net			102				-				(11	)			-				113				(1027	)%
Total non-operating income (expense), net		$	176				2	%		$	108				2	%		$	68				63	%
Income tax expense		$	-				-			$	(7	)			-			$	7				(100	)%

 

Interest Income and Expense

 

Interest income decreased 92% in the three months ended September 30, 2014 as compared to the same period in 2013. This decrease is due to the amortization of the principal investment in higher yield collateralized debt obligations. Interest income, decreased 37% in the nine months ended September 30, 2014 as compared to the same period in 2013.

 

Interest expense, primarily consisting of interest paid on capital leases, decreased during the nine months ended September 30, 2014, as compared to the three months ended September 30, 2013. Interest expense, primarily consisting of interest paid on capital leases, decreased during the nine months ended September 30, 2014, as compared to the nine months ended September 30, 2013. This decrease was primarily due to the final pay-off of capital lease obligations in the first quarter of 2013.

 

 

Liquidity and Capital Resources

 

Cash flows were as follows for the nine months ended September 30, 2014, and 2013 (in thousands):

 

		Nine Months Ended September 30,
		2014				2013				Change
Net cash used in operating activities		$	(3,300	)		$	(4,315	)		$	1,015
Net cash provided by investing activities			2,072				920				1,152
Net cash used in financing activities			(309	)			(127	)			(182	)
Effect of exchange rate changes on cash and cash equivalents			(95	)			(17	)			(78	)
Increase in cash and cash equivalents		$	(1,632	)		$	(3,539	)		$	1,907

 

Cash, cash equivalents and short- and long-term investment balances were as follows as of September 30, 2014, and December 31, 2013 (in thousands):

 

		September 30, 2014				December 31, 2013				Change
Cash and cash equivalents		$	1,157			$	2,789			$	(1,632	)
Short-term investments			158				3,102				(2,944	)
Long-term investments			-				154				(154	)
Total		$	1,315			$	6,045			$	(4,730	)
% of total assets			21	%			52	%
Total assets		$	6,216			$	11,646

 

At September 30, 2014, we had $1.3 million of cash, cash equivalents and short-term marketable investments. Cash equivalents and short-term marketable investments are comprised of highly liquid debt instruments of the U.S. government, commercial paper, time deposits, money market mutual funds, U.S. corporate securities, collateralized debt obligations and other commodities. 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 2 to the Unaudited Consolidated Financial Statements, “Cash and Available for Sale Securities,” which describes further the composition of our cash, cash equivalents and short-term investments.

 

Cash, cash equivalents and short- and long-term investments decreased $4.7 million to $1.3 million at September 30, 2014, from $6.0 million at December 31, 2013, primarily due to operating losses.

 

Our primary source of liquidity is our cash, cash equivalents, and short-term investments. Our current primary use of cash is to fund operating losses and investment in software development.  We believe that our existing cash, cash equivalents, and short-term investments will be sufficient to satisfy our current anticipated cash requirements through at least the next 12 months. Our liquidity could be negatively affected by a decrease in demand for our services beyond the current quarter, and changes in customer buying behavior. 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 nine months ended September 30, 2014, consisted of our net loss adjusted for certain non-cash items, including depreciation, amortization, provision for doubtful accounts, and share-based compensation expense, as well as the effect of changes in working capital and other activities. Cash used in operations in the nine months of 2014 was $3.3 million and consisted of a net loss of $5.1 million, adjustments for non-cash items of $1.1 million and cash used by working capital and other activities of $0.06 million. Adjustments for non-cash items primarily consisted of $1.0 million of depreciation and amortization expense on property and equipment, $0.08 amortization of deferred rent, $0.06 in amortization of deferred lease incentive, and $0.2 million in other non-cash charges. In addition, changes in working capital activities primarily consisted of a $0.04 million net increase in accounts payable and accrued liabilities, an increase of $0.1 million in accounts receivable and a $0.5 million decrease in prepaid and other assets. The decrease in accounts payable and accrued liabilities was primarily due to decreased TAC and operating expenses. The increase in accounts receivable is primarily attributed to slower paying customers.

 

Cash used in operating activities in the nine months ended September 30, 2013, consisted of our net loss adjusted for certain non-cash items, including depreciation, amortization, provision for doubtful accounts, and share-based compensation expense, as well as the effect of changes in working capital and other activities. Cash used in operations in the nine months of 2013 was $4.3 million and consisted of a net loss of $3.4 million, adjustments for non-cash items of $0.5 million and cash used by working capital and other activities of $1.4 million. Adjustments for non-cash items primarily consisted of $0.2 million of depreciation and amortization expense on property and equipment, $0.2 million in bad debt expense and $0.03 million of share-based compensation expense. In addition, changes in working capital activities primarily consisted of a $1.5 million net decrease in accounts payable and accrued liabilities, combined with a decrease of $1.2 million in accounts receivable. The decrease in accounts payable and accrued liabilities was primarily due to decreased TAC and operating expenses. The decrease in accounts receivable is primarily attributed to a decrease in invoiced customer revenue.

 

Investing Activities

 

Cash provided by investing activities in the nine months of 2014 of $2.07 million was attributed to $3.2 million net proceeds from the sale of investments partially offset by a $1.0 million in purchases of property and equipment.

 

Cash used in investing activities in the first half of 2013 of $0.1 million was attributed to $0.1 million net purchase of investments.

 

Financing Activities

 

Cash used in financing activities in the first half of 2014 of $0.3 million is attributed to $0.1 million in scheduled capital lease payments and $0.2 million is the repurchase of the Company’s common stock.

 

Cash used in financing activities in the half of 2013 of $0.1 million is primarily attributed to scheduled capital lease payments.

 

Credit Arrangements

 

We have an outstanding standby letter of credit issued by CNB of approximately $0.1 million at September 30, 2014, related to security of our corporate office lease, which is secured by a restricted money market account held at 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, 2013, we believe that there have been no material changes in contractual obligations or commercial commitments outside the ordinary course of business, during the nine months ended September 30, 2014.

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Pursuant to Section 229.305(e) of Regulation S-K, as a smaller reporting company, we are not required to provide information regarding quantitative and qualitative disclosures about market risk.

 

 

ITEM 4.

CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Our management, with the participation of our chief executive officer and principal financial and accounting officer, evaluated the effectiveness of disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (“Exchange Act”), as of the end of the period covered by this Quarterly Report on From 10-Q.

 

In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 

Based on this evaluation, our chief executive officer and principal financial and accounting officer concluded, as of September 30, 2014, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that the information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and principal financial and accounting officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2014, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II

 

ITEM 1.

LEGAL PROCEEDINGS

 

On September 4, 2013, Cowen and Company, LLC filed a complaint against LookSmart with the Superior Court of California for the County of San Francisco. According to the complaint, Cowen claims that LookSmart is required by an engagement letter dated August 14, 2009 to pay Cowen a $1,000,000 "Sale Transaction Fee" as a result of the third-party tender offer consummated for LookSmart Ltd. by PEEK Investments LLC on January 14, 2013. The parties agreed to a $450,000 settlement at a June 10, 2014 mediation. This amount was subsequently paid by the Company on July 11, 2014. The Complaint and Counter Claims were dismissed on August 27, 2014.

 

On October 3, 2013, WeBoost Media S.R.L., a Societa responsabilita ("WeBoost") filed a complaint against LookSmart with the Superior Court of California for the County of San Francisco. The matter was subsequently removed and is currently pending before the United States District Court, Northern District of California. WeBoost’s complaint asserts claims for breach of contract and extra-contractual tort and punitive damages related to "click fraud".  No specific monetary amounts are indicated in the complaint. LookSmart believes the claims are meritless and continues to vigorously defend the matter. The Company is presently unable to determine the risk of loss associated with this matter..

 

 

The Company is involved, from time to time, in various other legal proceedings arising from the normal course of business activities. Although the results of litigation and claims cannot be predicted with certainty, we do 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 our future results of operations, cash flows or financial position. Regardless of the outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors.

 

ITEM 1A.

RISK FACTORS

 

Other than the risk factors below, there have been no material changes to the risk factors as set forth in the Company’s Annual Report filed on Form 10-K for the year ended December 31, 2013. You should carefully consider the risks described below before making an investment decision regarding our common stock. If any of the following events described as a company risk factor actually occur, our business, financial condition and results of operations could be harmed. In that case, the trading price of our common stock could decline and our investors could lose all or part of their investment. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations.

 

Risks Related to our Business

 

We generated net losses in 2013, 2012 and for the three and nine months ended September 30, 2014, have had losses in the past, and may have further losses in the future. Failure to maintain operating profitability could harm our business and result in a decline in our stock price.

 

We had a net loss of $5.2 million in 2013 and $11 million in 2012. We had net losses of $1.3 million and $5.1 million for the three and nine months ended September 30, 2014, respectively. As of December 31, 2013, our accumulated deficit was $253 million. We may be unable to achieve profitability in the foreseeable future. Our ability to achieve and maintain profitability will depend on our ability to generate additional revenue and contain our expenses. In order to generate additional revenue, we will need to expand our network of distribution network partners, increase the amount our search advertising customers spend on our advertising network, expand our advertiser base, experience an increase in paid clicks across our network and publisher products and develop and implement successful new digital advertising revenue generating models. We may be unable to accomplish some or any of these goals because of the risks identified in this report or for unforeseen reasons. Also, we may be unable to contain our costs due to the need to make revenue sharing payments to our distribution network partners, to invest in product development and to market our products. Historically, our operating expenses have increased in proportion to our revenue. Operating expenses may increase in the foreseeable future to the extent that our revenue grows and as we increase headcount, particularly our sales and technology-related headcount, incur general and administrative expenses associated with being a public company and expand our facilities. Additionally, our acquisition-related costs may increase if we pursue additional acquisition opportunities. Although we expect to achieve operating efficiencies and greater leverage of resources as we grow, because of the foregoing factors, and others outlined in this report, we may be unable to achieve profitability in the future, which could result in a decline in our stock price.

 

Our financial results are highly concentrated in the online search advertising business; if we are unable to grow online search advertising revenues and find alternative sources of revenue, our financial results will suffer.

 

Search advertising accounted for substantially all of our revenues for the years ended December 31, 2012 and 2013. Our success depends upon search advertising customers choosing to use, and distribution network partners choosing to distribute, our search advertising networks products. Decisions by search advertising customers and distribution network partners not to adopt our products at projected rates, or changes in market conditions, may adversely affect the use or distribution of search advertisements. Because of our revenue concentration in the online search advertising business, such shortfalls or changes could have a negative impact on our financial results. Also, many of our products are offered to website publishers who use them to display or generate revenue from their online advertisements. If we are unable to generate significant revenue from our online advertising business or related business models under development, or if market conditions adversely affect the use or distribution of online advertisements generally, or for some of our larger customers specifically, our results of operations, financial condition and/or liquidity will suffer.

 

 

Our largest category of customers have historically been Intermediaries, the majority of whom purchase clicks to sell into the affiliate networks of large search engine providers. In 2013, we experienced a further decrease in revenues due to loss of Intermediary business.

 

We operate 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 historically been Intermediaries, the majority of which purchase clicks to sell into the affiliate networks of large search engine providers. The Intermediary business model experienced a significant change in the fourth quarter of 2011.  Since then, we have seen our revenues from Intermediaries decreasing from prior levels, and have ceased business with several of our Intermediary customers. We do not expect significant future revenue growth in this area. If we are unable to identify and exploit alternative sources of profitable revenue, our results of operations, financial condition and/or liquidity will suffer.

 

We rely primarily on our distribution network partners to generate quality search queries and display advertisements that generate paid clicks; if we are unable to maintain or expand the scope and quality of this network, our ability to generate revenue may be seriously harmed.

 

The success of our online search advertisement products depends in large part on the size and quality of our distribution network of search queries. We may be unable to maintain or add partners of satisfactory quality in our distribution network at reasonable revenue-sharing rates, if at all. If we lose any significant portion of our distribution network, we would need to find alternative sources of quality click traffic to replace the lost paid clicks. In the past, we have lost portions of our distribution network and chose to remove those with poor quality. Although alternate sources of click traffic are currently available in the market, they may not be available at reasonable prices or may be of unacceptable quality. There is significant competition among advertising networks to sign agreements with traffic providers. We may be unable to negotiate and sign agreements with quality traffic providers on favorable terms, if at all. In order to attract higher quality traffic, we may have to pay high traffic acquisition costs which may adversely affect our gross margin and other financial results. If we are unable to attract higher quality traffic, or if we are otherwise unsuccessful in maintaining and expanding our distribution network, then our ability to generate revenue may be seriously harmed.

 

 

If we experience decreases to our match rate and/or revenue-per-click, or we are unable to rebuild our match rate, and/or revenue-per-click, our financial results may suffer.

 

We have experienced, and may continue to experience in the future, decreases in our average revenue-per-click (“RPC”) and average match rate, which is the rate at which our paid listings are matched against search queries from distribution network partners. Future decreases in RPC or average match rate may occur for a variety of reasons, including a change in customer mix, the erosion of our advertiser base, a reduction in average advertiser spend, a reduction in the number of listings purchased by search advertising customers, a lower number of bids on keywords, changes in the composition of our distribution network or for other reasons. If our RPC or average match rate falls for any reason, or if we are unable to grow our RPC and average match rate, then we may be unable to achieve our financial projections and our stock price would likely suffer.

 

Our growth depends on our ability to retain and grow our search advertising customer base; if our search advertising customer base and average search advertising customer spend falls, our financial results will suffer.

 

Our growth depends on our ability to build a search advertising customer base that corresponds with the characteristics of our distribution network. Our distribution network, which currently consists of a diversified set of distribution sources, may change as new distribution sources are added and old distribution sources are removed. Search advertising customers may view these changes to the distribution network negatively, and existing or potential search advertising customers may elect to purchase fewer or no advertisements for display on our distribution network. If this occurs, it is likely that our average RPC and average match rate may decline and our stock price would likely suffer.

 

 

We have launched a solution that is dependent on our customers’ use of search advertising. Any decrease in the use of search advertising or our inability to further penetrate mobile, social and display advertising channels would harm our business, growth prospects, operating results and financial condition.

 

We expect that search advertising will become a channel increasingly used by our customers in the foreseeable future. Should our customers lose confidence in the value or effectiveness of search advertising, the demand for our solutions may decline, which would harm our growth prospects, operating results and financial condition.

 

If we cannot increase the capacity of our advertising technology platform to meet advertiser demand, our business will be harmed.

 

We must be able to continue to increase the capacity of our technology platforms in order to support substantial increases in the number of advertisers, to support an increasing variety of advertising formats and to maintain a stable service infrastructure and reliable service delivery for advertising campaigns. If we are unable to efficiently and effectively increase the scale of our advertising platforms to support and manage a substantial increase in the number of advertisers, while also maintaining a high level of performance, the quality of our services could decline and our reputation and business could be seriously harmed. In addition, if we are not able to support emerging advertising formats or services preferred by advertisers, we may be unable to obtain new advertising clients or may lose existing advertising customers, and in either case our revenue could decline.

 

If we are unable to attract new advertising customers and sell additional offerings to our existing customers, our revenue growth will be adversely affected.

 

To sustain or increase our revenue, we must add new advertisers and encourage existing advertisers (both of which are often represented by advertising agencies or other Intermediaries), to purchase additional offerings from us. As the digital advertising industry matures and as competitors introduce lower cost or differentiated products or services that compete with or are perceived to compete with ours, our ability to sell our solution to new and existing advertisers based on our offerings, pricing, technology platform and functionality could be impaired. Some advertisers that are repeat users of our solution tend to increase their spend over time. Conversely, some advertisers that are newer to our solution tend to spend less than, and may not return as frequently as, advertisers who have used our solution for longer periods of time. If we fail to retain or cultivate the spending of our newer, lower-spending advertisers, it will be difficult for us to sustain and grow our revenue from existing advertisers. Even with long-time advertisers, we may reach a point of saturation at which we cannot continue to grow our revenue from those advertisers because of internal limits that advertisers may place on the allocation of their advertising budgets to digital media, to particular campaigns, to a particular provider, or for other reasons not known to us. If we are unable to attract new advertisers or obtain new business from existing advertisers, our revenue growth and our business may be adversely affected.

 

If we do not introduce new and upgraded products and services and successfully adapt to our rapidly changing industry, our financial condition may suffer.

 

The online search advertising industry continues to evolve and we will need to continue developing new and upgraded products and services, and adapt to new business environments and competition in order to maintain and grow revenue and reach our profitability goals. New search advertising technologies could emerge that make our services comparatively less useful or new business methods could emerge that divert web traffic away from our advertising network. In addition, competition from other web businesses may prevent us from attracting substantial traffic to our services. We may inaccurately predict trends in the online search advertising market, which could lead us to make investments in technologies and products that do not generate sufficient returns. We may face platform and resource constraints that prevent us from developing upgraded products and services. We may fail to successfully identify new products or services, or fail to bring new products or services to market in a timely and efficient manner. Rapid industry change makes it difficult for us to accurately anticipate customer needs for our products, particularly over longer periods.

 

 

We may not be able to compete successfully against current and future competitors because competition in our industry is intense, and our competitors may offer solutions that are perceived by our customers to be more attractive than ours. These factors could result in declining revenue, or inability to grow our business.

 

Competition for our advertiser customers’ advertising budgets is intense. We also expect competition to increase as the barriers to enter our market are low. Increased competition may force us to charge less for our solution, or offer pricing models that are less attractive to us and decrease our margins. Our principal competitors include companies that offer demand side and data management platforms that allow advertisers to purchase inventory directly from advertising exchanges or other third parties and manage and analyze their own consumer data, traditional advertising networks and advertising agencies themselves. We compete with large companies that provide paid placement products, paid inclusion products, and other forms of search marketing as well as contextually-targeted advertising products and other types of online advertisements. We compete for search advertising customers on the basis of the quality and composition of our network, the price-per-click (“PPC”) charged to search advertising customers, the volume of clicks that we can deliver to search advertising customers, tracking and reporting of campaign results, customer service, and other factors. We also compete for distribution network partners and for ad placement on those partners’ sites on the basis of the relevance of our ads and the PPC charged to search advertising customers. We also experience competition in offering our publisher products to website publishers. Some of our competitors have larger distribution networks and proprietary traffic bases, longer operating histories, greater brand recognition, higher RPC, better relevance and conversion rates, or better products and services than we have.

 

We compete with companies such as Google and Apple, both of which are significantly larger than us and have more capital to invest in their advertising businesses. We also compete with in-house solutions used by companies who choose to coordinate advertising across their own properties, such as Facebook, Twitter, Yahoo! and Pandora. They, or other companies that offer competing advertising solutions, may establish or strengthen cooperative relationships with their partners, brand advertisers, app developers or other parties, thereby limiting our ability to promote our services and generate revenue. Competitors could also seek to gain market share from us by reducing the prices they charge to advertisers or by introducing new technology tools for developers. Moreover, increased competition for online advertising space from developers could result in an increase in the portion of advertiser revenue that we must pay to developers to acquire that advertising space.

 

Our business will suffer to the extent that our Intermediary and advertiser customers purchase and sell advertising directly from each other or through other companies that are able to become Intermediaries. For example, we are aware of companies that have substantial existing platforms for developers who had previously not heavily used those platforms for advertising campaigns. These companies could compete with us to the extent they expand into advertising. Other companies, such as large app developers with a substantial advertising business, may decide to directly monetize some or all of their advertising space without utilizing our services. Other companies that offer analytics, mediation, exchange or other third party services may also become Intermediaries between advertisers and publishers and thereby compete with us. Any of these developments would make it more difficult for us to sell our services and could result in increased pricing pressure, reduced profit margins, increased sales and marketing expenses or the loss of market share.

 

We do not have long-term commitments from our advertisers, and we may not be able to retain advertisers or attract new advertisers that provide us with revenue that is comparable to the revenue generated by any advertisers we may lose.

 

Most of our advertisers do business with us by placing insertion orders for particular advertising campaigns. If we perform well on a particular campaign, then the advertiser, or most often, the advertising agency representing the advertiser, may place new insertion orders with us for additional advertising campaigns. We rarely have any commitment from an advertiser beyond the campaign governed by a particular insertion order. As a result, our success is dependent upon our ability to outperform our competitors and win repeat business from existing advertisers, while continually expanding the number of advertisers for whom we provide services. In addition, it is relatively easy for advertisers and the advertising agencies that represent them to seek an alternative provider for their advertising campaigns because there are no significant switching costs. Agencies, with whom we do the majority of our business, often have relationships with many different providers, each of whom may be running portions of the same advertising campaign. Because we generally do not have long-term contracts, it may be difficult for us to accurately predict future revenue streams. We cannot provide assurance that our current advertisers will continue to use our solution, or that we will be able to replace departing advertisers with new advertisers that provide us with comparable revenue.

 

If we serve our advertisers’ advertisements on undesirable websites, our reputation will suffer, which would harm our brand and reputation and negatively impact our business, financial condition and results of operations.

 

Our business depends in part on providing advertisers with a service that they trust. We take action in an effort to prevent advertisements from appearing on undesirable websites. We may distribute advertising to inventory that is objectionable to advertisers, and we may lose the trust of our advertiser customers, which would harm our brand and reputation and negatively impact our business, financial condition and results of operations.

 

 

If our access to quality advertising inventory is diminished or if we fail to have access to new advertising inventory, our revenue could decline and our growth could be impeded.

 

We must maintain a consistent supply of attractive advertising inventory, meaning the digital space on which we place advertising impressions, including websites, proprietary social networks, such as Facebook, and mobile applications. Our success depends on our ability to secure quality inventory on reasonable terms across a broad range of advertising networks and exchanges, including real time advertising exchanges, such as Google’s DoubleClick Ad Exchange or AppNexus; suppliers of video and mobile inventory; and social media platforms, such as the Facebook Exchange, known as FBX.

 

The amount, quality and cost of inventory available to us can change at any time. Our suppliers are generally not bound by long-term contracts. As a result, we cannot provide any assurance that we will have access to a consistent supply of quality inventory. Moreover, the number of competing intermediaries that purchase advertising inventory from real-time advertising exchanges continues to increase, which could put upward pressure on inventory costs. If we are unable to compete favorably for advertising inventory available on real-time advertising exchanges, or if real-time advertising exchanges decide not to make their advertising inventory available to us, we may not be able to place advertisements at competitive rates or find alternative sources of inventory with comparable traffic patterns and consumer demographics in a timely manner. Furthermore, the inventory that we can access through real-time advertising exchanges may be of low quality or misrepresented to us, despite attempts by us and our suppliers to prevent fraud and conduct quality assurance checks.

 

Suppliers control the bidding process for the inventory they supply, and their processes may not always work in our favor. For example, suppliers may place restrictions on the use of their inventory, including restrictions that prohibit the placement of advertisements on behalf of certain advertisers. Through the bidding process, we may not win the right to deliver advertising to the inventory that we select and may not be able to replace inventory that is no longer made available to us.

 

If we are unable to maintain a consistent supply of quality inventory for any reason, our business, advertiser retention and loyalty, financial condition and results of operations would be harmed.

 

If our access to quality inventory in social media is diminished or if we fail to acquire new advertising inventory in social media, our growth could be impeded and our revenue could decline.

 

If we are unable to compete favorably for advertising inventory on Facebook’s FBX, our social media offering may not be successful. Also, we cannot provide assurance that Facebook will continue to make its advertising inventory available to us upon reasonable terms or at all, and we may not be able to replace the FBX advertising inventory with inventory that meets our advertisers’ specific goals with respect to social media. In addition, advertisers may prefer to work with companies that provide advertising on social media platforms other than FBX or that have a longer history of integration with social media platforms. If we are unable to run advertising campaigns on the FBX platform, integrate with social media platforms that may become available in the future or find alternative sources of quality social media inventory, our business could be harmed.

 

If mobile connected devices, their operating systems or content distribution channels, including those controlled by our competitors, develop in ways that prevent our advertising campaigns from being delivered to their users, our ability to grow our business will be impaired.

 

Our success in the mobile channel depends upon the ability of our technology platform to integrate with mobile inventory suppliers and provide advertising for most mobile connected devices, as well as the major operating systems that run on them and the thousands of applications that are downloaded onto them. The design of mobile devices and operating systems is controlled by third parties with whom we do not have any formal relationships. These parties frequently introduce new devices, and from time to time they may introduce new operating systems or modify existing ones. Network carriers may also impact the ability to access specified content on mobile devices. If our solution were unable to work on these devices or operating systems, either because of technological constraints or because an operating system or app developer, device maker or carrier wished to impair our ability to purchase inventory and provide advertisements, our ability to generate revenue could be significantly harmed.

 

 

If we do not deliver quality traffic that delivers value for advertisers, then our advertisers and our advertising partners may pay us less for their listing or discontinue listing with us altogether.

 

For our services to be successful, we need to deliver consumers to advertisers’ websites that are valuable to such advertiser. If we do not meet advertisers’ expectations by delivering quality traffic, then our advertising partners may pay us less per click or cease doing business with us altogether, which may adversely affect our business and financial results. We compete with other web search services, online publishers and high-traffic websites, as well as traditional media such as television, radio and print, for a share of our advertisers’ total advertising expenditures. Many potential advertisers and advertising agencies have only limited experience advertising on the Internet and have not devoted a significant portion of their advertising expenditures to search advertising. Acceptance of our advertising offerings among our advertisers and advertising partners will depend, to a large extent, on its perceived effectiveness and the continued growth of commercial usage of the Internet. If we experience downward pricing pressure for our services in the future, our financial results may suffer.

 

We depend on publishers for advertising space to deliver our advertiser customers’ advertising campaigns, and any decline in the supply of advertising inventory from these publishers could hurt our business.

 

We depend on publishers, both search and social media, to provide us with space (advertising inventory) into which to distribute advertisements. There is no contractually bound obligation to make advertising inventory available to us or our customers, or to provide us with a consistent supply of advertising inventory. Furthermore, there are tools that exist that parties could use which could result in pressure to increase the prices paid to publishers for that inventory or to otherwise block access to this inventory, without which we would be unable to facilitate the distribution of ads on behalf of our advertiser customers.

 

Publishers can change the amount of inventory they make available to us at any time. They may also change the price at which they offer inventory, or they may elect to make advertising space available to our competitors who offer ads to them on more favorable economic terms. In addition, publishers may place significant restrictions on use of their advertising inventory. These restrictions may prohibit ads from specific advertisers or specific industries, or they could restrict the use of specified creative content or format. Publishers may also use a fee-based or subscription-based business model to generate revenue from their content, in lieu of or to reduce their reliance on ads.

 

If publishers decide not to make advertising inventory available to us for any of these reasons, decide to increase the price of inventory, or place significant restrictions on our use of their advertising space, we may not be able to replace this with inventory from other publishers that satisfy our requirements in a timely and cost-effective manner. If this happens, our revenue could decline or our cost of acquiring inventory could increase.

 

We do not have long-term agreements with our advertiser customers, and we may be unable to retain key customers, attract new customers or replace departing customers with customers that can provide comparable revenue to us.

 

Our success requires us to maintain and expand our current advertiser customer relationships and to develop new relationships. Our contracts with our advertiser customers generally do not include long-term obligations requiring them to purchase our services and are cancelable upon short or no notice and without penalty. As a result, we may have limited visibility as to our future advertising revenue streams. We cannot assure you that our advertiser customers will continue to use our services or that we will be able to replace, in a timely or effective manner, departing customers with new customers that generate comparable revenue. If a major advertising customer representing a significant portion of our business decides to materially reduce its use of our platform or to cease using our platform altogether, our revenue could be significantly reduced. Advertisers in general may shift their business to a competitor’s platform because of new or more compelling offerings, strategic relationships, technological developments, pricing and other financial considerations, or a variety of other reasons, which could cause an immediate and significant decline in our revenue and harm our business.

 

Our acquisition of businesses and technologies may be costly and time-consuming; acquisitions may also dilute our existing stockholders.

 

From time to time we evaluate strategic corporate development opportunities and when appropriate, may make acquisitions of or significant investments in complementary companies or technologies to increase our technological capabilities expand our service offerings, or extend the operating scale of our network businesses. The pursuit of acquisitions, whether or not completed, as well as the completion of any acquisitions and their integration, may be expensive and may divert the attention of management from the day-to-day operations of the company. It may be difficult to retain key management and technical personnel of the acquired company during the transition period following an acquisition. Acquisitions or other strategic transactions may also result in dilution to our existing stockholders if we issue additional equity securities or increase our debt to pay for such acquisitions. We may also be required to amortize significant amounts of intangible assets, record impairment of goodwill in connection with future acquisitions, or divest non-performing assets at below-market prices, all of which would adversely affect our operating results. Integration of acquired companies and technologies into the company is likely to be expensive, time-consuming, and strain our managerial resources. We may not be successful in integrating any acquired businesses or technologies and these transactions may not achieve anticipated business benefits.

 

 

If we fail to make the right investment decisions in our offerings and technology platform, we may not attract and retain advertisers and advertising agencies and our revenue and results of operations may decline.

 

We compete for advertisers, which are often represented by advertising agencies, who want to purchase digital media for advertising campaigns. Our industry is subject to rapid changes in standards, technologies, products and service offerings, as well as in advertiser demands and expectations. We continuously need to make decisions regarding which offerings and technology to invest in to meet advertiser demand and evolving industry standards and regulatory requirements. We may make wrong decisions regarding these investments. For example, we expect advertisers to award us credit, or attribution, for impressions that generate specific consumer purchases or responses using certain criteria such as last ad clicked or viewed. Our technology considers these attribution models and if new attribution models are introduced by advertisers, we may need to make changes in our technology. If new or existing competitors offer more attractive offerings, we may lose advertisers or advertisers may decrease their spending on our solution. New advertiser demands, superior competitive offerings or new industry standards could render our existing solution unattractive, unmarketable or obsolete and require us to make substantial unanticipated changes to our technology platform or business model. Our failure to adapt to a rapidly changing market or to anticipate advertiser demand could harm our business and our financial performance.

 

If we fail to develop widespread brand awareness cost-effectively, our business may suffer.

 

We believe that developing and maintaining widespread awareness of our brand in a cost-effective manner is critical to achieving widespread acceptance of our products and attracting new customers. We expect sales and marketing expenses to increase as a result of our marketing and brand promotion activities. We may not generate customer awareness or increase revenues enough to offset the increased expenses we incur in building our brand. If we fail to successfully promote and maintain our brand, or incur substantial marketing and sales expenses, which are not offset by increased revenues, we may fail to attract or retain customers necessary to realize a sufficient return on our brand-building efforts, or to achieve the widespread brand awareness that is essential for broad customer adoption of our solution.

 

Failure to adequately manage our growth may seriously harm our business.

 

We have in the past experienced, and may again in the future experience, significant growth in our business. If we do not effectively manage our growth, the quality of our services may suffer, which could negatively affect our reputation and demand for our services. Our growth has placed, and is expected to continue to place, a significant strain on our managerial, administrative, operational and financial resources and our infrastructure. Our future success will depend, in part, upon the ability of our senior management to manage growth effectively. This will require us to, among other things:

 

 

• implement additional management information systems;

 

• further develop our operating, administrative, legal, financial and accounting systems and controls;

 

• hire additional personnel;

 

• develop additional levels of management within our company;

 

• locate additional office space;

 

• maintain close coordination among our engineering, operations, legal, finance, sales and marketing and client service and support organizations; and

 

Moreover, as our sales increase, we may be required to concurrently deploy our services infrastructure at multiple additional locations or provide increased levels of customization. As a result, we may lack the resources to deploy our services on a timely and cost-effective basis. Failure to accomplish any of these requirements could impair our ability to deliver our mobile advertising platform in a timely fashion, fulfill existing client commitments or attract and retain new clients.

 

Our success depends on our ability to attract and retain key personnel; if we were unable to attract and retain key personnel in the future, our business could be materially and adversely impacted.

 

Our success depends on our ability to identify, attract, retain and motivate highly skilled development, technical, sales, and management personnel. We have a limited number of key development, technical, sales and management personnel performing critical company functions, and the loss of the services of any of our key employees, particularly any of our executive team members or key technical personnel, could adversely affect our business. The combination of stock volatility of Company stock and the Company’s small market capitalization may not allow us to offer competitive equity based compensation to attract and retain key personnel.

 

If we do not attract additional sales and technology talent, we may not be able to sustain our growth or achieve our business objectives.

 

Our future success also depends on our ability to continue to attract, retain and motivate highly skilled managers and employees, particularly employees with technical skills that enable us to deliver effective mobile advertising solutions and sales, and client support representatives with experience in mobile and other digital advertising and strong relationships with brand advertisers and app developers. Competition for these employees in our industry is intense. As a result, we may be unable to attract or retain these management, technical, sales and client support personnel that are critical to our success, resulting in harm to our key client relationships, loss of key information, expertise or know-how and unanticipated recruitment and training costs. The loss of the services of our senior management or other key employees could make it more difficult to successfully operate our business and pursue our business goals.

 

We face capacity constraints on our software and infrastructure systems that may be costly and time-consuming to resolve.

 

We use proprietary and licensed software and databases to receive and analyze advertisements, campaigns and budgets, match search queries to advertising, analyze webpage information to match advertising to relevant content, integrate third-party ads, detect invalid clicks, serve ads in high volume, and track, analyze and report on advertising responses and campaigns. Any of these software systems may contain undetected errors, defects or bugs, or may fail to operate with other software applications. The following developments may strain our capacity and result in technical difficulties with our service or the websites of our distribution network partners:

 

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customization of our matching algorithms and ad serving technologies,

 

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substantial increases in the number of queries to our database,

 

 

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substantial increases in the number of searches in our advertising databases, or

 

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the addition of new products or features, or changes to our products.

 

If we experience difficulties with our software and infrastructure systems or if we fail to address these difficulties in a timely manner, we may lose the confidence of search advertisers and distribution network partners, our revenue may decline and our business could suffer. In addition, as we expand our service offerings and enter into new business areas, we may be required to significantly modify and expand our software and infrastructure systems. If we fail to accomplish these tasks in a timely manner, our business will likely suffer.

 

Our inability to use software licensed from third parties, or our use of open source software under license terms that interfere with our proprietary rights, could disrupt our business.

 

Our technology platform incorporates software licensed from third parties, including some software, known as open source software, which we use without charge. Although we monitor our use of open source software, the terms of many open source licenses to which we are subject have not been interpreted by U.S. or foreign courts, and there is a risk that such licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to provide our platform to our clients. While we monitor our use of open source software and try to ensure that none is used in a manner that would require us to disclose our source code or that would otherwise breach the terms of an open source agreement, such use could inadvertently occur. In the future, we could be required to seek licenses from third parties in order to continue offering our platform, which licenses may not be available on terms that are acceptable to us, or at all. Alternatively, we may need to re-engineer our platform or discontinue use of portions of the functionality provided by our platform. In addition, the terms of open source software licenses may require us to provide software that we develop using such software to others on unfavorable license terms. We may be required to release our proprietary source code, pay damages for breach of contract, discontinue sales in the event re-engineering cannot be accomplished on a timely basis or take other remedial action that may divert resources away from our development efforts. Our inability to use third party software could result in disruptions to our business, or delays in the development of future offerings or enhancements of existing offerings, which could impair our business.

 

If we fail to maintain adequate security and supporting infrastructure as we scale our systems, we may experience outages and disruptions of our services which could harm our brand and reputation and negatively impact our revenue and results of operations.

 

As we grow our business, we expect to continue to further invest in technology services, hardware and software, including data centers, network services, storage and database technologies. Creating the appropriate support for our technology platform, including Big Data and our computational infrastructure, is expensive and complex, and our execution could result in inefficiencies or operational failures and increased vulnerability to cyber-attacks, which, in turn, could diminish the quality of our services and our performance for advertisers. The steps we take to increase the reliability, integrity and security of our systems as they scale may be expensive and may not prevent system failures or unintended vulnerabilities resulting from the increasing number of persons with access to our systems, complex interactions within our technology platform and the increasing number of connections with third party partners and vendors’ technology. Operational errors or failures or successful cyber-attacks could result in damage to our reputation and loss of current and new advertisers and other business partners which could harm our business. In addition, we could be adversely impacted by outages and disruptions in the online platforms of our key business partners, such as the real-time advertising exchanges, who we rely upon for access to inventory.

 

In November of 2013, we acquired a data center facility in Phoenix, Arizona. The facility is vulnerable to damage or service interruption resulting from human error, intentional bad acts, earthquakes, hurricanes, floods, fires, war, terrorist attacks, power losses, hardware failures, systems failures, telecommunications failures and similar events. Moreover, while we have a disaster recovery plan in place, we do not maintain a “hot failover” instance of our software platform permitting us to immediately switch over in the event of damage or service interruption at our data center. The occurrence of a natural disaster or an act of terrorism, any outages or vandalism or other misconduct, or a decision to close the facility without adequate notice or other unanticipated problems could result in lengthy interruptions in our services.

 

Any changes in service levels at the facility or any errors, defects, disruptions or other performance problems at or related to the facility that affect our services could harm our reputation and may damage our customers’ businesses. Interruptions in our services might reduce our revenues, subject us to potential liability, or result in reduced usage of our platform. In addition, some of our customer contracts require us to issue credits for downtime in excess of certain levels and in some instances give our customers the ability to terminate their subscriptions.

 

 

Our data and information systems and network infrastructure may be subject to hacking or other cyber security threats. If our security measures are breached and an unauthorized party obtains access to our customer data or our proprietary business information, our information systems may be perceived as being unsecure, which could harm our business and reputation, and our proprietary business information could be misappropriated which could have an adverse effect on our business and results of operations.

 

In our operations, we store and transmit our proprietary information and information related to our customers. Our operations are dependent upon the connectivity and continuity of our facilities and operations. Despite our security measures, our information systems and network infrastructure may be vulnerable to cyber-attacks or could be breached due to an employee error or other disruption that could result in unauthorized disclosure of sensitive information which has the potential to significantly interfere with our business operations. Breaches of our security measures could expose us to a risk of loss or misuse of this information, litigation and potential liability. Since techniques used to obtain unauthorized access or to sabotage information systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures in advance of such an attack on our systems. In addition, if we select a vendor that uses cyber or “cloud” storage of information as part of their service or product offerings, despite our attempts to validate the security of such services, our proprietary information may be misappropriated by third parties. In the event of an actual or perceived breach of our security, or the security of one of our vendors, the market perception of the effectiveness of our security measures could be harmed and we could suffer damage to our reputation or our business, or lose existing customers and lose our ability to obtain new customers. Additionally, misappropriation of our proprietary business information could prove competitively harmful to our business.

 

Errors or failures in our software and systems could adversely affect our operating results and growth prospects.

 

We depend upon the sustained and uninterrupted performance of our technology platform to operate over 1,000 campaigns at any given time; manage our inventory supply; bid on inventory for each campaign; serve or direct a third party to serve advertising; collect, process and interpret data to optimize campaign performance in real time; and provide billing information to our financial systems. If our technology platform cannot scale to meet demand, or if there are errors in our execution of any of these functions on our platform, then our business could be harmed. Because our software is complex, undetected errors and failures may occur, especially when new versions or updates are made. We do not have the capability to test new releases or updates to our code on a small subset of campaigns, which means that bugs or errors in code could impact all campaigns on our platform. Despite testing by us, errors or bugs in our software have in the past, and may in the future, not be found until the software is in our live operating environment. For example, we may experience failures in our bidding system to recognize or respond to budget restrictions for campaigns, resulting in overspending on media, and we may in the future have failures in our systems that cause us to buy more media than our advertisers are contractually obligated to pay for, which could be costly and harm our operating results. Errors or failures in our software could also result in negative publicity, damage to our brand and reputation, loss of or delay in market acceptance of our solution, increased costs or loss of revenue, loss of competitive position or claims by advertisers for losses sustained by them. In such an event, we may be required or choose to expend additional resources to help mitigate any problems resulting from errors in our software. We may make errors in the measurement of our campaigns causing discrepancies with our advertisers’ measurements leading to a lack in confidence with us or, on occasion, the need for advertiser “make-goods,” the standard credits given to advertisers for campaigns that have not been delivered properly. Alleviating problems resulting from errors in our software could require significant expenditures of capital and other resources and could cause interruptions, delays or the cessation of our business, any of which would adversely impact our financial position, results of operations and growth prospects.

 

Software and components that we incorporate into our advertising platform may contain errors or defects, which could harm our reputation and hurt our business.

 

We use a combination of custom and third party software, including open source software, in building our advertising platforms. Although we test software before incorporating it into our platforms, we cannot guarantee that all of the third party technology that we incorporate will not contain errors, bugs or other defects. We continue to launch enhancements to our mobile advertising platform, and we cannot guarantee any such enhancements will be free from these kinds of defects. If errors or other defects occur in technology that we utilize in our mobile advertising platform, it could result in damage to our reputation and losses in revenue, and we could be required to spend significant amounts of additional resources to fix any problems.

 

The recent global financial crisis, uncertainty in global economic conditions and our history of losses may have significant negative effects on our access to credit and our ability to raise capital.

 

The recent global financial crisis which has included, among other things, significant reductions in and heightened credit quality standards for available capital and liquidity from banks and other providers of credit, substantial reductions and/or fluctuations in equity and currency values worldwide, and concerns that the worldwide economy may enter into a prolonged recessionary period, may make it difficult for us to raise additional capital or obtain additional credit, when needed, on acceptable terms or at all. We may need to enter into additional credit facilities in the future to operate the business. Our history of operating losses may make it more difficult for us to obtain additional financing for our operations, investing activities, or financing activities. This difficulty or inability could materially limit our business operations and adversely affect our business performance.

 

 

If we do not comply with the financial covenants in our credit agreements, our financial condition could be adversely affected.

 

Our credit facilities contain provisions that could limit our ability to, among other things, incur, create or assume additional debt, sell or otherwise dispose of our or any of our subsidiaries’ assets, or consolidate or merge with or into, or acquire the obligations or stock of, or any other interest in, another person. In addition, our credit facilities contain financial covenants that require us to maintain specified levels of tangible net worth and liquid assets. Our ability to meet those financial covenants can be affected by events beyond our control, and we may be unable to satisfy these covenants. If we fail to comply with these covenants, we may be required to identify restricted cash equal to our outstanding capital lease balance, if any, plus our outstanding standby letter of credit (“SBLC”) or, in the event of default, we may be required to pay the lenders cash in an amount equal to the capital lease balance, if any is outstanding. Paying such cash balances could have a material adverse effect on the Company’s financial condition.

 

Risks Related to Operating in our Industry

 

Economic downturns and political and market conditions beyond our control could adversely affect our business, financial condition and results of operations.

 

Our business depends on the overall demand for advertising and on the economic health of our current and prospective advertisers. Economic downturns or instability in political or market conditions may cause current or new advertisers to reduce their advertising budgets. Adverse economic conditions and general uncertainty about economic recovery are likely to affect our business prospects. In particular, uncertainty regarding the budget crisis in the United States may cause general business conditions in the United States and elsewhere to deteriorate or become volatile, which could cause advertisers to delay, decrease or cancel purchases of our solution, This could expose us to increased credit risk on advertiser orders, which, in turn, could negatively impact our business, financial condition and results of operations. In addition, concerns over the sovereign debt situation in certain countries in the EU as well as continued geopolitical turmoil in many parts of the world have, and may continue to, put pressure on global economic conditions, which could lead to reduced spending on advertising.

 

Cyclical and seasonal fluctuations in the economy, in internet usage and in traditional retail shopping may have an effect on our business.

 

Both cyclical and seasonal fluctuations in internet usage and traditional retail seasonality may affect our business. Internet usage generally slows during the summer months, and queries typically increase significantly in the fourth quarter of each year. These seasonal trends may cause fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates.

 

Seasonal fluctuations in advertising activity could adversely affect our cash flows.

 

Our cash flows from operations could vary from quarter to quarter due to the seasonal nature of our advertisers’ spending. For example, many advertisers devote the largest portion of their budgets to the fourth quarter of the calendar year, to coincide with increased holiday purchasing. To date, these seasonal effects have been masked by our rapid revenue growth. However, if and to the extent that seasonal fluctuations become more pronounced, our operating cash flows could fluctuate materially from period to period as a result.

 

If we fail to prevent, detect and remove invalid search queries and clicks, we could lose the confidence of our search advertisers, thereby causing our business to suffer.

 

Invalid clicks are an ongoing problem for the Internet search advertising industry, and we are exposed to the risk of invalid clicks on customers’ text advertisements coming from within our distribution network. Invalid clicks occur when a person or robotic software causes a click on a paid listing to occur for some reason other than to view the underlying content. Invalid clicks are commonly referred to as “click fraud.” We continue to invest significant time and resources in preventing, detecting and eliminating invalid traffic from our distribution network. However, the perpetrators of click fraud have developed sophisticated methods to evade detection, and we are unlikely to be able to completely detect and remove all invalid traffic from our search network.

 

 

We have in the past been subject to advertiser complaints and litigation regarding invalid clicks, and we may be subject to search advertising customer complaints, claims, litigation or inquiries in the future. We have from time to time credited invoices or refunded revenue to our customers due to invalid traffic, and we expect to continue to do so in the future. If our systems to detect invalid traffic are insufficient, or if we find new evidence of past invalid clicks, we may have to issue credits or refunds retroactively to our search advertisers, and we may still have to pay revenue share to our distribution network partners. This could negatively affect our profitability and hurt our brand. If traffic consisting of invalid clicks is not detected and removed from our advertising network, the affected search advertising customers may experience a reduced return on their investment in our online advertising because the invalid clicks will not lead to conversions for the search advertising customers. This could lead the search advertisers to become dissatisfied with our products, which could lead to loss of search advertising customers and revenue and could materially and adversely affect our financial results.

 

We compete with many companies, some of whom are more established and better capitalized than us.

 

We compete with a variety of companies on a worldwide basis both through the Internet and in traditional markets. Many of these companies are larger and better capitalized than us. There are also few barriers to entry in our markets. Our competitors may develop services that are superior to, or have greater market acceptance than our services. For example, many of our current and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources and larger customer bases than us. These factors may allow our competitors to respond more quickly than we can to new or emerging technologies and changes in customer requirements. Our competitors may engage in more extensive research and development efforts, undertake more far-reaching marketing campaigns and adopt more aggressive pricing policies which may allow them to build larger client bases. In addition, current and potential competitors are making, and are expected to continue to make, strategic acquisitions or establish cooperative, and, in some cases, exclusive relationships with significant companies or competitors to expand their businesses or to offer more comprehensive products and services.

 

System failures could significantly disrupt our operations and cause us to lose advertiser customers or advertising inventory.

 

Our success depends on the continuing and uninterrupted performance of our own internal systems, which we utilize to distribute and place ads, monitor the performance of advertising campaigns and manage inventory of advertising space. Our revenue depends on the technological ability of our platforms to deliver ads and measure them on a per click basis. Sustained or repeated system failures that interrupt our ability to provide services to customers, including technological failures affecting our ability to deliver ads quickly and accurately and to process users’ responses to ads, could significantly reduce the attractiveness of our services to advertisers and reduce our revenue. Our systems are vulnerable to damage from a variety of sources, including telecommunications failures, power outages, malicious human acts and natural disasters. In addition, any steps we take to increase the reliability and redundancy of our systems may be expensive and may not ultimately be successful in preventing system failures.

 

Any failure in the performance of our key production systems could materially and adversely affect our revenues.

 

Any system failure that interrupts our hosted products or services, whether caused by computer viruses, software failure, power interruptions, intruders, hackers, or other causes, could harm our financial results. For example, our system for tracking and invoicing clicks is dependent upon a proprietary software platform. If we lose key personnel or experience a failure of software, this system may fail. In such event, we may be unable to track paid clicks and invoice our customers, which would materially and adversely affect our financial results and business reputation. Moreover, our services are governed by Service Level Agreements that, if not met, require the payment of credits to our customers depending upon the level of service interruption.

 

The occurrence of a natural disaster or unanticipated problems at our principal headquarters or at a third-party data center could cause interruptions or delays in our business. A loss of data could render us unable to provide some services. Our California facilities exist on or near known earthquake fault zones and a significant earthquake could cause an interruption in our services. An interruption in our ability to serve advertisements, track paid clicks, bill and collect invoices, and provide customer support would materially and adversely affect our financial results.

 

Our business and operations depend on Internet service providers and third party technology providers, and any failure or system downtime experienced by these companies could materially and adversely affect our revenues.

 

Our distribution network partners and search advertising customers depend on Internet service providers, online service providers and other third parties for access to our services. These service providers have experienced significant outages in the past and could experience outages, delays and other operating difficulties in the future. The occurrence of any or all of these events could adversely affect our reputation, brand and business, which could have a material adverse effect on our financial results.

 

 

We currently have a data center in Phoenix to house equipment for web serving and networking and to provide network connectivity services. We also have agreements with third-party click tracking and ad-serving technology providers. We do not presently maintain fully redundant click tracking, customer account, and web serving systems at separate locations. Accordingly, our operations depend on the data center to protect the systems from system failures, earthquake, fire, power loss, water damage, telecommunications failure, hacking, vandalism, and similar events. Our data center and partners do not guarantee that our Internet access will be uninterrupted, error-free or secure. Although we maintain property insurance and business interruption insurance, such insurance may not protect against some risks and we cannot guarantee that our insurance will be adequate to compensate us for all losses that may occur as a result of a catastrophic system failure. Also, if our third-party click tracking or ad-serving technology providers experience service interruptions, errors or security breaches, our ability to track, realize, and record revenue would suffer.

 

We may face liability for claims related to our products and services, and these claims may be costly to resolve.

 

Internet users, search advertisers, other customers, and companies in the Internet, technology and media industries frequently enter into litigation based on allegations related to defamation, negligence, personal injury, breach of contract, unfair advertising, unfair competition, invasion of privacy, patent infringement or other claims. Lawsuits are filed against us from time to time. As we enter foreign markets, our potential liability could increase. In addition, we are obligated in some cases to indemnify our customers or distribution network partners in the event that they are subject to claims that our services infringe on the rights of others.

 

Litigating these claims could consume significant amounts of time and money, divert management’s attention and resources, cause delays in integrating acquired technology or releasing new products, or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on acceptable terms, if at all. Our insurance may not adequately cover claims of this type, if at all. If a court were to determine that some aspect of our services infringed upon or violated the rights of others, we could be prevented from offering some or all of our services, which would negatively impact our revenue and business. For any of the foregoing reasons, litigation involving our listings business and technology could have a material adverse effect on our business, operating results and financial condition.

 

Our failure to protect our intellectual property rights could diminish the value of our services, weaken our competitive position and reduce our revenue.

 

We regard the protection of our intellectual property, which includes trade secrets, patents, copyrights, trademarks, domain names and patent applications, as critical to our success. We strive to protect our intellectual property rights by relying on federal, state and common law rights, as well as contractual restrictions. We enter into confidentiality and invention assignment agreements with our employees and contractors, and confidentiality agreements with third parties with whom we conduct business in order to limit access to, and disclosure and use of, our intellectual property and proprietary information. However, these contractual arrangements and the other steps we have taken to protect our intellectual property may not prevent the misappropriation of our proprietary information or deter independent development of similar technologies by others.

 

We seek patent protection for certain of our technologies and currently have several issued U.S. and international patents, and pending international and domestic patent applications. There can be no assurance that these additional patents will ultimately be issued. We are also pursuing the registration of our domain names, trademarks and service marks in the United States and in certain locations outside the United States. Effective trade secret, copyright, trademark, domain name and patent protection is expensive to develop and maintain, both in terms of initial and ongoing registration requirements and the costs of defending our rights. We may be required to protect our intellectual property in an increasing number of jurisdictions, a process that is expensive and may not be successful or which we may not pursue in every location. We may, over time, increase our investment in protecting our intellectual property through additional patent filings that could be expensive and time-consuming.

 

We have licensed in the past, and expect to license in the future, some of our proprietary rights, such as trademarks or copyrighted material, to third parties. These licensees may take unauthorized actions that diminish the value of our proprietary rights or harm our reputation.

 

Monitoring unauthorized use of our intellectual property is difficult and costly. Our efforts to protect our proprietary rights may not be adequate to prevent misappropriation of our intellectual property. Further, we may not be able to detect unauthorized use of, or take appropriate steps to enforce, our intellectual property rights. Our competitors may also independently develop similar technology. In addition, the laws of many countries, such as China and India, do not protect our proprietary rights to as great an extent as do the laws of European countries and the United States. Further, the laws in the United States and elsewhere change rapidly, and any future changes could adversely affect us and our intellectual property rights. Our failure to meaningfully protect our intellectual property could result in competitors offering services that incorporate our most technologically advanced features, which could seriously reduce demand for our mobile advertising services. In addition, we may in the future need to initiate infringement claims or litigation. Litigation, whether we are a plaintiff or a defendant, can be expensive, time-consuming and may divert the efforts of our technical staff and managerial personnel, which could harm our business, whether or not such litigation results in a determination that is unfavorable to us. In addition, litigation is inherently uncertain, and thus we may not be able to stop our competitors from infringing upon our intellectual property rights.

 

 

We could be subject to infringement claims that may be costly to defend, result in the payment of settlements or damages or cause us to change the way we conduct our business.

 

Internet, technology and media companies, as well as patent holding companies often possess a significant number of patents. Further, many of these companies and other parties are actively developing online advertising, search, indexing, electronic commerce and other Web-related technologies, as well as a variety of online business models and methods. We believe that these parties will continue to take steps to protect these technologies, including, but not limited to, seeking patent protection. As a result, we may face claims of infringement of patents and other intellectual property rights held by others. Also, as we expand our business, acquire and maintain our customer base, and develop new technologies, products and services, we may become increasingly subject to intellectual property infringement claims. In the event that there is a claim or determination that we infringe third-party proprietary rights such as patents, copyrights, trademark rights, trade secret rights or other third party rights such as publicity and privacy rights, we could incur substantial monetary liability, be required to enter into costly royalty or licensing agreements or be prevented from using the rights, which could require us to change our business practices in the future and limit our ability to compete effectively. We may also incur substantial expenses in defending against third-party infringement claims regardless of the merit of such claims. The occurrence of any of these results could harm our brand and negatively impact our operating results. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain third-party intellectual property infringement claims or determinations, which could increase our costs in defending such claims and our damages. For example, in October 2008, we agreed to indemnify one of our Publisher Solutions customers relating to a patent infringement suit filed against it pursuant to an AdCenter for Publishers’ agreement between it and the Company. The resulting settlement agreement between the Company and the plaintiffs required us to pay the plaintiffs $0.6 million and the Publisher Solutions customer’s defense costs of $0.4 million.

 

Litigation, regulation, legislation or enforcement actions directed at or materially affecting us may adversely affect the commercial use of our products and services and our financial results.

 

New lawsuits, laws, regulations and enforcement actions applicable to the online industry may limit the delivery, appearance and content of our advertising or our publisher customers’ advertisers or otherwise adversely affect our business. If such laws are enacted, or if existing laws are interpreted to restrict the types and placements of advertisements we or our publishers’ customers can carry, it could have a material and adverse effect on our financial results. For example, in 2002, the Federal Trade Commission, in response to a petition from a private organization, reviewed the way in which search engines disclose paid placement or paid inclusion practices to Internet consumers and issued guidance on what disclosures are necessary to avoid misleading consumers about the possible effects of paid placement or paid inclusion listings on the search results. In 2003, the United States Department of Justice issued statements indicating its belief that displaying advertisements for online gambling might be construed as aiding and abetting an illegal activity under federal law. In 2004, the United States Congress considered new laws regarding the sale of pharmaceutical products over the Internet and the use of adware to distribute advertisements on the Internet. In 2007, the Federal Trade Commission proposed new regulations relating to online behavioral targeting. Moreover, as we enter into foreign markets, we may become subject to additional regulation and legislation. If any new law or government agency were to require changes in the labeling, delivery or content of our advertisements, or if we are subject to legal proceedings regarding these issues, it may reduce the desirability of our services or the types of advertisements that we can run, and our business could be materially and adversely harmed. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain claims related to online advertising laws, regulations and enforcement actions, which could increase our costs in defending such claims and our damages.

 

In addition, legislation or regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), present ongoing compliance risks, and a failure to comply with these new laws and regulations could materially harm our business. As we continue our Section 404 compliance efforts we may identify significant deficiencies, or material weaknesses, in the design and operation of our internal control over financial reporting. We may be unable to remediate any of these matters in a timely fashion, and/or our independent registered public accounting firm may not agree with our remediation efforts. Such failures could impact our ability to record, process, summarize and report financial information, and could impact market perception of the quality of our financial reporting, which could adversely affect our business and our stock price.

 

On September 4, 2013, Cowen and Company, LLC filed a complaint against us claiming that we are required to pay them a $1,000,000 “Sale Transaction Fee” as a result of a third-party tender offer consummated by PEEK Investments LLC on January 14, 2013. While we believe the claims are meritless, mounting a vigorous defense of the matter could result in substantial costs and divert management’s attention and resources, and an adverse finding could seriously harm our business and its finances.

 

 

Activities of our advertiser customers could damage our reputation or give rise to legal claims against us.

 

Our advertiser customers’ promotion of their products and services may not comply with federal, state and local laws, including, but not limited to, laws and regulations relating to mobile communications. Failure of our customers to comply with federal, state or local laws or our policies could damage our reputation and expose us to liability under these laws. We may also be liable to third parties for content in the ads we deliver if the artwork, text or other content involved violates copyrights, trademarks or other intellectual property rights of third parties or if the content is defamatory, unfair and deceptive, or otherwise in violation of applicable laws. Although we generally receive assurance from our advertisers that their ads are lawful and that they have the right to use any copyrights, trademarks or other intellectual property included in an ad, and although we are normally indemnified by the advertisers, a third party or regulatory authority may still file a claim against us. Any such claims could be costly and time-consuming to defend and could also hurt our reputation. Further, if we are exposed to legal liability as a result of the activities of our advertiser clients, we could be required to pay substantial fines or penalties, redesign our business methods, discontinue some of our services or otherwise expend significant resources.

 

Our business practices with respect to data could give rise to liabilities or reputational harm as a result of governmental regulation, legal requirements or industry standards relating to consumer privacy and data protection.

 

In the course of providing our services, we transmit and store information related to the ads we place. Federal, state and international laws and regulations can govern the collection, use, retention, sharing and security of data that we collect across our advertising platform. We strive to comply with all applicable laws, regulations, policies and legal obligations relating to privacy and data protection. However, it is possible that these requirements may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another and may conflict with other rules or our practices. Any failure, or perceived failure, by us to comply with U.S. federal, state, or international laws, including laws and regulations regulating privacy, data security, or consumer protection, could result in proceedings or actions against us by governmental entities or others. We are aware of several ongoing lawsuits filed against companies in our industry alleging various violations of privacy-related laws. Any such proceedings could hurt our reputation, force us to spend significant amounts in defense of these proceedings, distract our management, increase our costs of doing business, adversely affect the demand for our services and ultimately result in the imposition of monetary liability. We may also be contractually liable to indemnify and hold harmless our clients from the costs or consequences of inadvertent or unauthorized disclosure of data that we store or handle as part of providing our services.

 

The regulatory framework for privacy issues worldwide is evolving, and various government and consumer agencies and public advocacy groups have called for new regulation and changes in industry practices. For example, in early 2012, the State of California entered into an agreement with several major mobile app platforms under which the platforms have agreed to require mobile apps to meet specified standards to ensure consumer privacy. Subsequently, in January 2013, the State of California released a series of recommendations for privacy best practices for the mobile industry. In January 2014, a California law also became effective amending the required disclosures for online privacy policies. It is possible that new laws and regulations will be adopted in the United States and internationally, or existing laws and regulations may be interpreted in new ways, that would affect our business.

 

As we expand our operations globally, compliance with regulations that differ from country to country may also impose substantial burdens on our business. In particular, the European Union has traditionally taken a broader view as to what is considered personal information and has imposed greater obligations under data privacy regulations. In addition, individual EU member countries have had discretion with respect to their interpretation and implementation of the regulations, which has resulted in variation of privacy standards from country to country. In January 2012, the European Commission announced significant proposed reforms to its existing data protection legal framework, including changes in obligations of data controllers and processors, the rights of data subjects and data security and breach notification requirements. The EU proposals, if implemented, may result in a greater compliance burden if we deliver ads to mobile device users in Europe. Complying with any new regulatory requirements could force us to incur substantial costs or require us to change our business practices in a manner that could compromise our ability to effectively pursue our growth strategy.

 

Privacy-related regulation of the Internet could limit the ways we currently collect and use personal information, which could decrease our advertising revenues or increase our costs.

 

Internet user privacy has become an issue both in the United States and abroad. The United States Congress and Federal Trade Commission are considering new legislation and regulations to regulate Internet privacy. The Federal Trade Commission and government agencies in some states and countries have investigated some Internet companies, and lawsuits have been filed against some Internet companies, regarding their handling or use of personal information. Any laws imposed to protect the privacy of Internet consumers may affect the way in which we collect and use personal information. We could incur additional expenses if new laws or court judgments, in the United States or abroad, regarding the use of personal information are introduced or if any agency chooses to investigate our privacy practices.

 

 

We, along with some of our distribution network partners or search advertising customers, retain information about our consumers. If others were able to penetrate the network security of these user databases and access or misappropriate this information, we and our distribution network partners or search advertising customers could be subject to liability. These claims may result in litigation, our involvement in which, regardless of the outcome, could require us to expend significant time and financial resources. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain claims related to privacy laws, regulations and enforcement actions which could increase our costs in defending such claims and damages.

 

Legislation and regulation of online businesses, including privacy and data protection regimes, could create unexpected costs, subject us to enforcement actions for compliance failures, or cause us to change our technology platform or business model, which could have a material adverse effect on our business.

 

Government regulation could increase the costs of doing business online. U.S. and foreign governments have enacted or are considering legislation related to online advertising and we expect to see an increase in legislation and regulation related to advertising online, the use of geo-location data to inform advertising, the collection and use of anonymous Internet user data and unique device identifiers, such as IP address or unique mobile device identifiers, and other data protection and privacy regulation. Recent revelations about bulk online data collection by the National Security Agency, and news articles suggesting that the National Security Agency may gather data from cookies placed by Internet advertisers to deliver interest based advertising, may further interest governments in legislation regulating data collection by commercial entities, such as advertisers and publishers and technology companies that serve the advertising industry. Such legislation could affect the costs of doing business online, and could reduce the demand for our solution or otherwise harm our business, financial condition and results of operations. For example, a wide variety of provincial, state, national and international laws and regulations apply to the collection, use, retention, protection, disclosure, transfer and other processing of personal data. While we have not collected data that is traditionally considered personal data, such as name, email address, address, phone numbers, social security numbers, credit card numbers, financial or health data, we may obtain information that are or may be considered personal data in some jurisdictions or otherwise may be the subject of legislation or regulation. Evolving and changing definitions of personal data, within the EU, the United States and elsewhere, could cause us in the future, to change our business practices, or limit or inhibit our ability to operate or expand our business. Data protection and privacy-related laws and regulations are evolving and could result in ever-increasing regulatory and public scrutiny and escalating levels of enforcement and sanctions. While we take measures to protect the security of information that we collect, use and disclose in the operation of our business, and to offer certain privacy protections with respect to such information, such measures may not always be effective. In addition, while we take steps to avoid collecting personally identifiable information about consumers, we may inadvertently receive this information from advertisers or advertising agencies or through the process of delivering advertising. Our failure to comply with applicable laws and regulations, or to protect personal data, could result in enforcement action against us, including fines, imprisonment of our officers and public censure, claims for damages by consumers and other affected individuals, damage to our reputation and loss of goodwill, any of which could have a material adverse impact on our business, financial condition and results of operations. Even the perception of privacy concerns, whether or not valid, could harm our reputation and inhibit adoption of our solution by current and future advertisers and advertising agencies.

 

If the use of “third party cookies” is rejected by Internet users, restricted or otherwise subject to unfavorable regulation, our performance could decline and we could lose advertisers and revenue.

 

Advertisers and our partners use “cookies” (small text files) to gather important data in the delivery of advertisements. These cookies are placed through an Internet browser on an Internet user’s computer and correspond to a data set. These cookies are known as “third party” cookies because of a lack of a direct relationship with the Internet user. These cookies collect anonymous information, such as when an Internet user views an ad, clicks on an ad, or visits one of our advertiser customer’s websites. On mobile devices, there may also be location based information about the user’s device. These cookies are used to help achieve our advertiser customer’s campaign goals, to help ensure that the same Internet user does not unintentionally see the same advertisement too frequently, to report aggregate information to advertisers regarding the performance of their advertising campaigns and to detect and prevent fraudulent activity throughout our network of inventory. Data from cookies are also used to help decide whether to bid on, and how much to bid on, an opportunity to place an advertisement in a certain location, at a given time, in front of a particular Internet user. A lack of data associated with cookies may detract from the ability to make decisions about which inventory to purchase for an advertiser’s campaign, and undermine the effectiveness of our solution.

 

Cookies may easily be deleted or blocked by Internet users. All of the most commonly used Internet browsers (including Chrome, Firefox, Internet Explorer, and Safari) allow Internet users to prevent cookies from being accepted by their browsers. Internet users can also delete cookies from their computers at any time. Some Internet users also download “ad blocking” software that prevents cookies from being stored on a user’s computer. If more Internet users adopt these settings or delete their cookies more frequently than they currently do, our business could be harmed. In addition, the Safari browser blocks cookies by default, and other browsers may do so in the future. Unless such default settings in browsers were altered by Internet users, we would be able to set fewer of our cookies in browsers, which could adversely affect our business. In addition, companies such as Google have publicly disclosed their intention to move away from cookies to another form of persistent unique identifier, or ID, to indicate Internet users in the bidding process on advertising exchanges. If companies do not use shared IDs across the entire ecosystem, this could have a negative impact on our ability to find the same anonymous user across different web properties, and reduce the effectiveness of our solution.

 

 

In addition, in the European Union, or EU, Directive 2009/136/EC, commonly referred to as the “Cookie Directive,” directs EU member states to ensure that accessing information on an Internet user’s computer, such as through a cookie, is allowed only if the Internet user has given his or her consent. We may not be able to develop or implement additional tools that compensate for the lack of data associated with cookies. Moreover, even if we are able to do so, such additional tools may be subject to further regulation, time consuming to develop or costly to obtain, and less effective than our current use of cookies.

 

Potential “Do Not Track” standards or government regulation could negatively impact our business by limiting access to the anonymous user data that informs the advertising campaigns we facilitate, and as a result could degrade our performance for our customers.

 

As the use of cookies has received ongoing media attention over the past three years, some government regulators and privacy advocates have suggested creating a “Do Not Track” standard that would allow Internet users to express a preference, independent of cookie settings in their web browser, not to have their website browsing recorded. All the major Internet browsers have implemented some version of a “Do Not Track” setting. Microsoft’s Internet Explorer 10 includes a “Do Not Track” setting that is selected “on” by default. However, there is no definition of “tracking,” no consensus regarding what message is conveyed by a “Do Not Track” setting and no industry standards regarding how to respond to a “Do Not Track” preference. It is possible that we could face competing policy standards, or standards that put our business model at a competitive disadvantage to other companies that collect data from Internet users, standards that reduce the effectiveness of our solution, or standards that require us to make costly changes to our solution. The Federal Trade Commission has stated that it will pursue a legislative solution if the industry cannot agree upon a standard. The “Do-Not-Track Online Act of 2013” was introduced in the United States Senate in February 2013. If a “Do Not Track” web browser setting is adopted by many Internet users, and the standard either imposed by state or federal legislation, or agreed upon by standard setting groups, requires us to recognize a “Do Not Track” signal and prohibits the use of non-personal data as currently done, then that could hinder growth of advertising and content production on the web generally, and limit the quality and amount of data we are able to store and use, which would cause us to change our business practices and adversely affect our business.

 

Our business involves the use, transmission and storage of confidential information, and the failure to properly safeguard such information could result in significant reputational harm and monetary damages.

 

We may at times collect, store and transmit information of, or on behalf of, our clients that may include certain types of confidential information that may be considered personal or sensitive, and that are subject to laws that apply to data breaches. We believe that we take reasonable steps to protect the security, integrity and confidentiality of the information we collect and store, but there is no guarantee that inadvertent or unauthorized disclosure will not occur or that third parties will not gain unauthorized access to this information despite our efforts to protect this information. If such unauthorized disclosure or access does occur, we may be required to notify persons whose information was disclosed or accessed. Most states have enacted data breach notification laws and, in addition to federal laws that apply to certain types of information, such as financial information, federal legislation has been proposed that would establish broader federal obligations with respect to data breaches. We may also be subject to claims of breach of contract for such disclosure, investigation and penalties by regulatory authorities and potential claims by persons whose information was disclosed. The unauthorized disclosure of information may result in the termination of one or more of our commercial relationships or a reduction in client confidence and usage of our services. We may also be subject to litigation alleging the improper use, transmission or storage of confidential information, which could damage our reputation among our current and potential clients, require significant expenditures of capital and other resources and cause us to lose business and revenue.

 

Online commerce security risks, including security breaches, identity theft, service disrupting attacks and viruses, could harm our reputation and the conduct of our business, which could have a material adverse effect on our financial results.

 

A fundamental requirement for online commerce and communications is the secure storage and transmission of confidential information over public networks. Although we have developed and use systems and processes that are designed to protect customer information and prevent fraudulent credit card transactions and other security breaches, our security measures may not prevent security breaches or identity theft that could harm our reputation and business. Currently, a significant number of our customers provide credit card and other financial information and authorize us to bill their credit card accounts directly for all transaction fees charged by us. We rely on encryption and authentication technology to provide the security and authentication to effect secure transmission of confidential information, including customer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology used by us to protect transaction data. In addition, any party who is able to illicitly obtain a user’s password could access the user’s transaction data. An increasing number of websites have reported breaches of their security. Any compromise of our security could damage our reputation and expose us to a risk of litigation and possible liability. The coverage limits of our insurance policies may not be adequate to reimburse us for losses caused by security breaches.

 

 

Additionally, our servers are vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions, and we have experienced “denial-of-service” type attacks on our system that have made all or portions of our websites unavailable for periods of time. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches. Disruptions in our services and damage caused by viruses and other attacks could cause a loss of user confidence in our systems and services, which could lead to reduced usage of our products and services and materially adversely affect our business and financial results.

 

Our data and information systems and network infrastructure may be subject to hacking or other cyber security threats. If our security measures are breached and an unauthorized party obtains access to our customer data or our proprietary business information, our information systems may be perceived as being unsecure, which could harm our business and reputation, and our proprietary business information could be misappropriated which could have an adverse effect on our business and results of operations.

 

In our operations, we store and transmit our proprietary information and information related to our customers. Our operations are dependent upon the connectivity and continuity of our facilities and operations. Despite our security measures, our information systems and network infrastructure may be vulnerable to cyber-attacks or could be breached due to an employee error or other disruption that could result in unauthorized disclosure of sensitive information which has the potential to significantly interfere with our business operations. Breaches of our security measures could expose us to a risk of loss or misuse of this information, litigation and potential liability. Since techniques used to obtain unauthorized access or to sabotage information systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures in advance of such an attack on our systems. In addition, if we select a vendor that uses cyber or “cloud” storage of information as part of their service or product offerings, despite our attempts to validate the security of such services, our proprietary information may be misappropriated by third parties. In the event of an actual or perceived breach of our security, or the security of one of our vendors, the market perception of the effectiveness of our security measures could be harmed and we could suffer damage to our reputation or our business, or lose existing customers and lose our ability to obtain new customers. Additionally, misappropriation of our proprietary business information could prove competitively harmful to our business.

 

New tax treatment of companies engaged in Internet commerce may adversely affect the commercial use of our search service and our financial results.

 

Tax authorities at the international, federal, state and local levels are currently reviewing the appropriate tax treatment of companies engaged in Internet commerce. New or revised state tax regulations may subject us or our search advertising customers to additional state sales, income and other taxes. We cannot predict the effect of current attempts to impose sales, income or other taxes on commerce over the Internet. New or revised taxes and, in particular, sales taxes, would likely increase the cost of doing business online and decrease the attractiveness of advertising and selling goods and services over the Internet. Any of these events could have an adverse effect on our business and results of operations.

 

Risks Related to the Capital Market

 

Our securities may be delisted.

 

The NASDAQ Stock Market requires us to satisfy certain continued listing requirements, including maintaining a minimum closing bid price for our common stock of at least $1.00 per share. No assurance can be given that we will remain in compliance with all of the NASDAQ Stock Market’s continued listing requirements. If delisting were to occur, our securities will not enjoy the same liquidity as shares that are traded on the NASDAQ Stock Market or a national U.S. securities exchange and investors may find that it is more difficult to obtain accurate and timely quotations. As a result, the price of our securities would likely decline.

 

Our quarterly revenues and operating results may fluctuate for many reasons, which may make our future results difficult to predict and could cause our operating results to fall below investors’ and analysts; expectations, negatively affecting our stock price.

 

Our revenues and operating results have fluctuated in the past, and will likely fluctuate significantly from quarter to quarter as a result of a variety of factors, many of which are beyond our control. Because our business is changing and evolving rapidly, our historical operating results may not be useful in predicting our future operating results. Factors that may cause fluctuations in our operating results include, without limitation:

 

 

¨

changes in the composition and size of our Advertiser Network customer base;

 

¨

change in composition of our AdCenter customer base;

 

the seasonal nature of our customers’ spending on digital advertising campaigns;

 

the pricing of advertising inventory or of other third-party services;

 

¨

changes in our distribution network, particularly the gain or loss of key distribution network partners, or changes in the implementation of search results on partner websites;

 

¨

changes in the intermediary business model which affect the entire online search advertising ecosystem;

 

¨

changes in the number of search advertising customers who do business with us, or the amount of spending per customer;

 

the introduction of new technologies, product or service offerings by our competitors;

 

changes in our customers’ advertising budget allocations, agency affiliations or marketing strategies;

 

¨

the revenue-per-click we receive from search advertising customers, or other factors that affect the demand for, and prevailing prices of, Internet advertising and marketing services;

 

¨

changes to our traffic acquisition costs related to our Advertiser Network, including changes to the economic prospects of our advertisers generally, which could alter current or prospective advertisers’ spending priorities and increase the time or costs required to complete sales with advertisers;

 

changes and uncertainty in the regulatory environment for us or our advertisers;

 

changes in the availability of advertising inventory through real-time advertising exchanges, or in the cost to reach end consumers through digital advertising;

 

changes in our capital expenditures as we acquire the hardware, equipment and other assets required to support our business;

 

costs related to the acquisition of people, business or technologies; and

 

¨

systems downtime on our Advertiser Network, our website or the websites of our distribution network partners.

 

Due to the above factors, we believe that period-to-period comparisons of our financial results are not necessarily meaningful, and you should not rely on past financial results as an indicator of our future performance. If our financial results in any future period fall below the expectations of securities analysts and investors, the market price of our securities would likely decline.

 

Our stock price is extremely volatile, and such volatility may hinder investors’ ability to resell their shares for a profit or avoid a loss.

 

The stock market has experienced significant price and volume fluctuations in recent years, and the stock prices of Internet companies have been extremely volatile. The low trading volume of our common stock may adversely affect its liquidity and reduce the number of market makers and/or large investors willing to trade in our common stock, making wider fluctuations in the quoted price of our common stock more likely to occur. You should evaluate our business in light of the risks, uncertainties, expenses, delays and difficulties associated with managing and growing a business in a relatively new industry, many of which are beyond our control.

 

Our stock price may fluctuate, and you may not be able to sell your shares for a profit, as a result of a number of factors, including, without limitation:

 

¨

developments concerning proprietary rights, including patents, by us or a competitor;

 

¨

announcements by us or our competitors of significant contracts, acquisitions, commercial relationships, joint ventures or capital commitments;

 

 

¨

introductions of new services by us or our competitors;

 

¨

enactment of new government regulations affecting our industry;

 

¨

changes in the market valuations of Internet companies in general and comparable companies in particular;

 

¨

quarterly fluctuations in our operating results;

 

¨

the termination or expiration of our distribution agreements;

 

¨

our potential failure to meet our forecasts or analyst expectations on a quarterly basis;

 

¨

the relatively thinly traded volume of our publicly traded shares, which means that small changes in the volume of trades may have a disproportionate impact on our stock price;

 

¨

the loss of key personnel, or our inability to recruit experienced personnel to fill key positions;

 

¨

changes in ratings or financial estimates by analysts or the inclusion/removal of our stock from certain stock market indices used to drive investment choices;

 

¨

announcements of new distribution network partnerships, technological innovations, acquisitions or products or services by us or our competitors;

 

¨

the short selling of our stock;

 

¨

the sales of substantial amounts of our common stock in the public market by our stockholders, or the perception that such sales could occur; or

 

¨

conditions or trends in the Internet that suggest a decline in rates of growth of advertising-based Internet companies.

 

In the past, securities class action litigation has often been instituted after periods of volatility in the market price of a Company’s securities. A securities class action suit against us could result in substantial costs and the diversion of management’s attention and resources, regardless of the merits or outcome of the case.

 

We may need additional capital in the future to support our operations and, if such additional financing is not available to us, on reasonable terms or at all, our liquidity and results of operations will be materially and adversely impacted.

 

Although we believe that our working capital will provide adequate liquidity to fund our operations and meet our other cash requirements for the foreseeable future, unanticipated developments in the short term, such as the entry into agreements which require large cash payments or the acquisition of businesses with negative cash flows, may necessitate additional financing. We may seek to raise additional capital through public or private debt or equity financings in order to:

 

¨

fund the additional operations and capital expenditures;

 

¨

take advantage of favorable business opportunities, including geographic expansion or acquisitions of complementary businesses or technologies;

 

¨

develop and upgrade our technology infrastructure beyond current plans;

 

¨

develop new product and service offerings;

 

¨

take advantage of favorable conditions in capital markets; or

 

¨

respond to competitive pressures.

 

Our audited consolidated financial statements for the fiscal year ended December 31, 2013, were prepared on a going concern basis in accordance with U.S. GAAP. The going concern basis of presentation assumes that we will continue in operation for the foreseeable future and will be able to realize our assets and discharge our liabilities and commitments in the normal course of business. However, the report of our independent registered public accounting firm on our audited consolidated financial statements for the fiscal year ended December 31, 2013, has indicated that we have incurred net loss since our inception, have experienced liquidity problems, negative cash flows from operations, and a working capital deficit at December 31, 2013, that may present some challenges to our ability to continue as a going concern.

 

 

The capital markets, and in particular the public equity market for Internet companies, have historically been volatile. It is difficult to predict when, if at all, it will be possible for Internet companies to raise capital through these markets. We cannot assure you that the additional financing will be available on terms favorable to us, or at all. If we issue additional equity or convertible debt securities, our existing stockholders may experience substantial dilution.

 

We do not anticipate paying any cash dividends on our common stock in the foreseeable future and our stock may not appreciate in value.

 

We have not declared or paid cash dividends on our common stock to date. We currently intend to retain our future earnings, if any, to fund the development and growth of our business. In addition, the terms of any existing or future debt agreements may preclude us from paying dividends. There is no guarantee that shares of our common stock will appreciate in value or that the price at which our stockholders have purchased their shares will be able to be maintained.

 

We will incur costs and demands upon management as a result of complying with the laws and regulations affecting public companies in the United States.

 

As a public company listed in the United States we incur significant legal, accounting and other expenses. In addition, changing laws, regulations and standards relating to corporate governance and public disclosure, including regulations implemented by the SEC and stock exchanges, may increase legal and financial compliance costs and make some activities more time consuming. These laws, regulations and standards are subject to varying interpretations and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If, notwithstanding our efforts to comply with new laws, regulations and standards, we fail to comply, regulatory authorities may initiate legal proceedings against us and our business may be harmed.

 

Failure to comply with these rules might also make it more difficult for us to obtain some types of insurance, including director and officer liability insurance, and we might be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on committees of our board of directors or as members of senior management

 

If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our operating results could fall below the expectations of investors and securities analysts, which could result in a decline in our stock price.

 

The preparation of financial statements in conformity with generally accepted accounting principles, or GAAP, requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances (as described in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”), the results of which form the basis for making judgments about the carrying values of assets, liabilities, equity, revenue and expenses that are not readily apparent from other sources. Our operating results could be adversely affected if our assumptions change or if actual circumstances differ from those in our assumptions. If, as a result, our operating results fall below the expectations of investors and securities analysts, our stock price could decline. Significant assumptions and estimates used in preparing our consolidated financial statements include those related to revenue recognition, stock-based compensation, allowance for doubtful accounts, accounting for internal use software and income taxes.

 

Concentration of ownership of our common stock among our existing executive officers, directors and principal stockholders may prevent new investors from influencing significant corporate decisions.

 

As of December 31, 2013, our executive officers, directors and current beneficial owners of 5% or more of our common stock and their respective affiliates, in the aggregate, beneficially owned approximately 78% of our outstanding common stock. These persons, acting together, are able to significantly influence all matters requiring stockholder approval, including the election and removal of directors and any merger or other significant corporate transactions. The interests of this group of stockholders may not coincide with our interests or the interests of other stockholders. This concentration of ownership may have the effect of deterring, delaying or preventing a change of control of our company, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company and might ultimately affect the market price of our common stock.

 

 

Provisions of Delaware corporate law and provisions of our charter and bylaws may discourage a takeover attempt.

 

Our charter and bylaws and provisions of Delaware law may deter or prevent a takeover attempt, including an attempt that might result in a premium over the market price for our common stock. Our board of directors has the authority to issue shares of preferred stock and to determine the price, rights, preferences and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. In addition, our charter and bylaws provide for a classified board of directors. These provisions, along with Section 203 of the Delaware General Corporation Law, prohibiting certain business combinations with an interested stockholder, could discourage potential acquisition proposals and could delay or prevent a change of control.

 

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements on a timely basis could be impaired.

 

We are subject to the reporting requirements of the Securities Exchange Act of 1934, the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the rules and regulations of the NASDAQ Stock Market. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal controls over financial reporting and perform system and process evaluation and testing of our internal controls over financial reporting to allow management to report on the effectiveness of our internal controls over financial reporting. This requires that we incur substantial professional fees and internal costs related to our accounting and finance functions and that we expend significant management efforts.

 

We may in the future discover areas of our internal financial and accounting controls and procedures that need improvement. Our internal control over financial reporting will not prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud will be detected.

 

If we are unable to maintain proper and effective internal controls in the future, we may not be able to produce timely and accurate financial statements, and we may conclude that our internal controls over financial reporting are not effective. If that were to happen, the market price of our stock could decline and we could be subject to sanctions or investigations by the NASDAQ Stock Market, the SEC or other regulatory authorities.

 

  

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

In May 2012, the Company's Board of Directors authorized the repurchase of up to $1 million of the Company's common shares. Under the program, the Company may purchase its common shares from time to time in the open market or in privately negotiated transactions. The following table details the repurchases made by the Company in the three and nine months ended September 30, 2014.

 

Period		Total Number of Shares Purchased				Average Price Paid per Share				Total Number of Shares Purchased as Part of Publicly Announced Programs				Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
Total at December 31, 2013											31,902			$	925,239
January 1 - January 31, 2014			1,195			$	2.05				1,195				923,011
Total at March 31, 2014			1,195			$	2.05				33,097			$	923,011
April 1 - April 30, 2014			4,755				1.88				4,755				914,056
May 1 - May 31, 2014			11,594				1.80				11,594				893,240
June 1 - June 30, 2014			26,939				1.89				26,939				842,417
Total at June 30, 2014			43,288			$	1.86				76,385			$	842,417
July 1 - July 31, 2014			8,105				1.86				8,105				827,374
August 1 - August 31, 2014			30,143				1.73				30,143				775,222
September 1 - September 30, 2014			15,492				1.57				15,492				750,872
Total at September 30, 2014			53,740			$	1.70				130,125			$	750,872

 

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.

MINE SAFETY DISCLOSURE

 

Not applicable.

 

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, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	LOOKSMART, LTD.
Date:  November 14, 2014	By:	/s/ STEVEN WANG
		Steven Wang
		V.P. Finance and Controller

 

 

EXHIBIT INDEX

 

Exhibits

 

Number		Description of Document
4.1		Form of Specimen Stock Certificate (Filed as Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on November 14, 2005).
4.2		Rights Agreement dated as of August 23, 2012 among LookSmart, Ltd. and Computershare Trust Company, N.A. (Filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 23, 2012).
31.1*		Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification of Principal Financial and Accounting Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.1*		Certification of Principal Financial and Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document

 

(*) Filed herewith