XNAS:LOOK LookSmart Ltd Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

XNAS:LOOK (LookSmart Ltd): Fair Value Estimate
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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 

FORM 10-Q
 

 
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the Quarterly Period Ended June 30, 2012
 
OR
 
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the Transition Period from              to             .

Commission File Number: 000-26357
 

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

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act 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
o
Accelerated filer
o
 
 
 
 
Non-accelerated filer
o
Smaller reporting company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes     No x
 
As of August 2, 2012 there were 17,293,237 shares of the registrant’s common stock outstanding, par value $0.001 per share.
 


 
 

 
 
TABLE OF CONTENTS
 
PART I. FINANCIAL INFORMATION
 
ITEM 1
  3
       
    3
       
    4
       
    5
       
    6
       
    7
       
ITEM 2.
  18
       
ITEM 3.
  25
       
ITEM 4.
  25
     
 
PART II. OTHER INFORMATION
 
       
ITEM 1.
  26 
       
ITEM 1A.
  26
       
ITEM 2.
  26
       
ITEM 3.
  26
       
ITEM 4.
  26
       
ITEM 5.
  26
       
ITEM 6.
  26
       
27
       
28


PART I
 
FINANCIAL STATEMENTS
 
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)

 
 
June 30,
2012
   
December 31,
2011
 
ASSETS
 
(Unaudited)
   
 
 
Current assets:
 
 
   
 
 
Cash and cash equivalents
  $ 11,506     $ 17,950  
Short-term investments
    8,694       6,809  
Total cash, cash equivalents and short-term investments
    20,200       24,759  
Trade accounts receivable, net
    1,496       1,588  
Prepaid expenses and other current assets
    556       604  
Total current assets
    22,252       26,951  
Property and equipment, net
    1,574       1,941  
Capitalized software and other assets, net
    1,474       1,220  
Total assets
  $ 25,300     $ 30,112  
                 
LIABILITIES & STOCKHOLDERS' EQUITY
               
Current liabilities:
               
Trade accounts payable
  $ 1,368     $ 1,682  
Accrued liabilities
    1,109       895  
Deferred revenue and customer deposits
    1,159       1,143  
Current portion of capital lease obligations
    313       515  
Total current liabilities
    3,949       4,235  
Capital lease and other obligations, net of current portion
    140       296  
Total liabilities
    4,089       4,531  
Commitment and contingencies
               
Stockholders' equity:
               
Convertible preferred stock, $0.001 par value; Authorized: 5,000 shares at June 30, 2012 and December 31, 2011; Issued and Outstanding: none at June 30, 2012 and December 31, 2011
    -       -  
Common stock, $0.001 par value; Authorized: 80,000 shares; Issued and Outstanding: 17,293 shares and 17,288 shares at June 30, 2012 and December 31, 2011, respectively
    17       17  
Additional paid-in capital
    262,335       262,201  
Accumulated other comprehensive loss
    (19 )     (24 )
Accumulated deficit
    (241,122 )     (236,613 )
Total stockholders' equity
    21,211       25,581  
Total liabilities and stockholders' equity
  $ 25,300     $ 30,112  
 
The accompanying Notes are an integral part of these Unaudited Consolidated Financial Statements.


CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
 
2012
   
2011
   
2012
   
2011
 
Revenue
  $ 3,574     $ 6,605     $ 7,587     $ 14,994  
Cost of revenue
    2,370       3,439       4,585       8,094  
Gross profit
    1,204       3,166       3,002       6,900  
Operating expenses:
                               
Sales and marketing
    753       558       1,459       1,167  
Product development and technical operations
    1,555       1,550       3,343       3,144  
General and administrative
    1,264       1,037       2,725       2,462  
Restructuring charge
    -       -       -       889  
Total operating expenses
    3,572       3,145       7,527       7,662  
Income (loss) from operations
    (2,368 )     21       (4,525 )     (762 )
Non-operating income (expense), net
                               
Interest income
    21       24       41       47  
Interest expense
    (9 )     (24 )     (21 )     (53 )
Other income (expense), net
    (3 )     333       (4 )     326  
Income (loss) from operations before income taxes
    (2,359 )     354       (4,509 )     (442 )
Income tax benefit
    -       -       -       1  
Net income (loss)
  $ (2,359 )   $ 354     $ (4,509 )   $ (441 )
Net income (loss) per share - Basic and Diluted
  $ (0.14 )   $ 0.02     $ (0.26 )   $ (0.03 )
Weighted average shares outstanding used in computing basic net income (loss) per share
    17,293       17,274       17,293       17,255  
Weighted average shares outstanding used in computing diluted net income (loss) per share
    17,293       17,368       17,293       17,255  

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


CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)

 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
 
2012
   
2011
   
2012
   
2011
 
Net income (loss)
  $ (2,359 )   $ 354     $ (4,509 )   $ (441 )
Other comprehensive income (loss):
                               
Foreign currency translation adjustments
    (12 )     -       (22 )     -  
Unrealized gain (loss) on marketable securities, net
    (2 )     4       27       15  
Change in accumulated other comprehensive income (loss)
    (14 )     4       5       15  
Comprehensive (income) loss
  $ (2,373 )   $ 358     $ (4,504 )   $ (426 )

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


LOOKSMART, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
 
Six Months Ended June 30,
 
 
 
2012
   
2011
 
Cash flows from operating activities:
 
 
   
 
 
Net loss
  $ (4,509 )   $ (441 )
Adjustment to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    1,094       1,409  
Provision for doubtful accounts
    293       35  
Share-based compensation
    121       165  
Loss from sale of assets and other non-cash charges
    38       46  
Deferred rent
    (14 )     (4 )
Gain on closure of settlement fund
    -       (339 )
Changes in operating assets and liabilities:
               
Trade accounts receivable
    (201 )     1,004  
Prepaid expenses and other current assets
    58       56  
Trade accounts payable
    (314 )     (1,173 )
Accrued liabilities
    214       (781 )
Deferred revenue and customer deposits
    16       18  
Net cash used in operating activities
    (3,204 )     (5 )
Cash flows from investing activities:
               
Purchase of investments
    (7,542 )     (15,367 )
Proceeds from sale of investments
    5,624       5,397  
Payments for property, equipment, and capitalized software
    (994 )     (503 )
Proceeds from contingent purchase consideration of certain consumer assets
    -       91  
Net cash used in investing activities
    (2,912 )     (10,382 )
Cash flows from financing activities:
               
Principal payments of capital lease obligations
    (344 )     (570 )
Proceeds from issuance of common stock
    9       66  
Net cash used in financing activities
    (335 )     (504 )
Effect of exchange rate changes on cash and cash equivalents
    7       -  
Decrease in cash and cash equivalents
    (6,444 )     (10,891 )
Cash and cash equivalents, beginning of period
    17,950       22,119  
Cash and cash equivalents, end of period
  $ 11,506     $ 11,228  
Supplemental disclosure of noncash activities:
               
Change in unrealized gain (loss) on investments
  $ 27     $ 15  
Share-based compensation capitalized as software development costs
  $ 4     $ 16  
 
The accompanying Notes are an integral part of these Unaudited Consolidated Financial Statements.


LOOKSMART, LTD. AND SUBSIDIARIES
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
1. Summary of Significant Accounting Policies
 
Nature of Business
 
LookSmart, Ltd. (“LookSmart” or the “Company”) is a search advertising network solutions company that provides relevant solutions for search advertisers and publishers. LookSmart was organized in 1996 and is incorporated in the State of Delaware.
 
LookSmart operates in a large online search advertising ecosystem serving ads that target user queries on partner sites. 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 search advertising customers are generally of three types; Intermediaries, Direct Advertisers and Self-Service Advertisers. Intermediaries purchase clicks to sell into the affiliate networks of the large search engine providers. Direct Advertisers and their agencies purchase clicks with the assistance of LookSmart account managers to achieve conversions or sales from the clicks or to obtain unique page views. Self-Service Advertisers are small Direct Advertisers that sign-up online, pay by credit card and manage their account with minimal LookSmart account management assistance.
 
LookSmart offers search advertising customers targeted search via a monitored search advertising distribution network using the Company’s “AdCenter” platform technology. The Company’s search advertising network includes publishers and search advertising customers, including Intermediaries and direct advertising customers and their agencies as well as self-service customers, in the United States and certain other countries. The Company’s application programming interface (“API”) allows search advertising customers and their advertising agencies to connect any type of marketing or reporting software with minimal effort, for easier access, management, and optimization of search advertising campaigns.
 
LookSmart also offers publishers licensed private-label search advertiser network solutions based on its AdCenter platform technology (“Publisher Solutions”). Publisher Solutions consist of hosted auction-based ad serving with an ad backfill capability that allows publishers and portals to manage their advertiser relationships, distribution channels and accounts.
 
Principles of Consolidation
 
The Unaudited Consolidated Financial Statements as of June 30, 2012 and December 31, 2011, and for the three and six months ended June 30, 2012 and 2011, include the accounts of the Company and its subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.
 
Unaudited Interim Financial Information
 
The accompanying Unaudited Consolidated Financial Statements as of June 30, 2012, and for the three and six months ended June 30, 2012 and 2011, reflect all adjustments that are normal and recurring in nature and, in the opinion of management, are necessary for a fair representation of the Company’s financial position as of June 30, 2012 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, 2011(“Annual Report”). The Consolidated Balance Sheet as of December 31, 2011 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 June 30, 2012 is 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 GAAP. This requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue, expenses, and contingent assets and liabilities during the reporting period. The Company bases its estimates on various factors and information which may include, but are not limited to, history and prior experience, experience of other enterprises in the same industry, new related events, and current economic conditions and information from third party professionals that is believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. In management’s opinion, all adjustments necessary for a fair statement are reflected in the interim periods presented.
 
Reclassifications
 
Certain amounts in the financial statements for the prior periods have been reclassified to conform to the current presentation. These reclassifications did not change the previously reported net loss, net change in cash and cash equivalents or stockholders’ equity.
 
Investments
 
The Company invests its excess cash primarily in debt instruments of high-quality corporate and government issuers. All highly liquid instruments with maturities at the date of purchase greater than ninety days are considered investments. Such securities are classified as short-term investments. These securities are classified as available-for-sale and carried at fair value.
 
Changes in the value of these investments are primarily related to changes in interest rates and are considered to be temporary in nature. Except for declines in fair value that are not considered temporary, net unrealized gains or losses on these investments are reported as a component of Other Comprehensive Income (Loss) in the Unaudited Consolidated Statements of Comprehensive Income (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 primarily composed of per-click fees that we charge customers. 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. 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 obligor 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. Our revenue reserves were insignificant and $0.3 million at June 30, 2012 and December 31, 2011, respectively.

Deferred revenue is recorded when payments are received in advance of performance in underlying agreements. Customer deposits are recorded when customers make prepayments for online advertising.
 
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 to determine whether a provision or reversal is required. The review is based on factors including the application of historical collection rates to current receivables and economic conditions. The Company will record an increase or reduction of its allowance for doubtful accounts if collection rates or economic conditions are more or less favorable than it anticipated. Additional allowances for doubtful accounts may be required if there is deterioration in past due balances, if economic conditions are less favorable than the Company anticipated or for customer-specific circumstances, such as bankruptcy. The allowance for doubtful accounts included in trade accounts receivable, net is $0.8 million and $0.6 million at June 30, 2012 and December 31, 2011, respectively. Bad debt allowance included in general and administrative expense was not significant and $0.3 million for three and six months ended June 30, 2012, respectively. Bad debt allowance included in general and administrative expense was not significant for both the three and six months ended June 30, 2011.
 
Concentrations, Credit Risk and Credit Risk Evaluation
 
Concentration of Credit Risk
 
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, investments, and accounts receivable. As of June 30, 2012 and December 31, 2011, the Company placed its cash equivalents and investments primarily through one financial institution, City National Bank (“CNB”), and mitigated the concentration of credit risk by placing percentage limits on the maximum portion of the investment portfolio which may be invested in any one investment instrument. These amounts exceed federally insured limits. 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.
 
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, if necessary. 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 gross accounts receivable:
 
 
 
 
June 30,
 
December 31,
 
 
 
2012
 
2011
Company 1
 
 
30%
 
**
Company 2
 
 
14%
 
20%
Company 3
 
 
**
 
12%
 

** Less than 10%
 
Revenue and Cost Concentrations
 
The following table reflects countries that accounted for more than 10% of net revenue:
 
 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
 
2012
   
2011
   
2012
   
2011
 
United States
    49 %     78 %     56 %     69 %
Europe, Middle East and Africa
    44 %     13 %     37 %     24 %

LookSmart derives its revenue from two service offerings, or “products”: Advertiser Networks and Publisher Solutions. The percentage distributions between the two service offerings are as follows:
 
 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
 
2012
   
2011
   
2012
   
2011
 
Advertiser Networks
    92 %     96 %     92 %     96 %
Publisher Solutions
    8 %     4 %     8 %     4 %

The following table reflects the percentage of revenue attributed to customers who accounted for more than 10% of net revenue.
 
 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
 
2012
   
2011
   
2012
   
2011
 
Company 1
    26 %     **       21 %     **  
Company 2
    **       13 %     **       **  
Company 3
    **       11 %     **       14 %
 

** Less than 10%
 
The Company derives its revenue primarily from its relationships with significant distribution network partners. The following table reflects the distribution partners that accounted for more than 10% of TAC:
 
 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
 
2012
   
2011
   
2012
   
2011
 
Distribution Partner 1
    26 %     **       22 %     **  
Distribution Partner 2
    **       **       11 %     **  
Distribution Partner 3
    **       **       10 %     **  
Distribution Partner 4
    13 %     **       **       **  
Distribution Partner 5
    10 %     **       **       **  
Distribution Partner 6
    **       **       **       11 %
 

 ** Less than 10%
 
 
Property and Equipment
 
Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets as follows:
 
Computer equipment
3 to 4 years
Furniture and fixtures
5 to 7 years
Software
2 to 3 years

Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the lease term.
 
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.
 
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.
 
Impairment of Long-Lived Assets
 
The Company reviews long-lived assets held or used in operations, including property and equipment and capitalized software development costs, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. Subject assets are tested for impairment at the lowest level of operations that generate cash flows that are largely independent of the cash flows from those of other groups of asset and liabilities. Management has determined that the equity of its single reporting unit is the lowest level of operation at which independent cash flows can be identified. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Impairment, if any, is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. Assets to be disposed of are reported at the lower of carrying amount or fair value less cost to dispose.
 
The Company tested its long-lived assets used in operations for impairment as of June 30, 2012 and determined there was no impairment.
 
Traffic Acquisition Costs
 
The Company enters into agreements of varying durations with its distribution network partners that display the Company’s listings ads on their sites in return for a percentage of the revenue-per-click that the Company receives when the ads are clicked on those partners’ sites.
 
The Company also enters into agreements of varying durations with third party affiliates. These affiliate agreements provide for variable payments based on a percentage of the Company’s revenue or based on a certain metric, such as number of searches or paid clicks.
 
The Company records TAC expenses as cost of revenue and TAC are expensed based on the volume of the underlying activity or revenue, multiplied by the agreed-upon price or rate.
 
Share-Based Compensation
 
The Company recognizes share-based compensation costs for all awards granted, including stock option grants, 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. The Company estimates the fair value of option awards on the grant date using the Black-Scholes method. The value of the portion of the award that is ultimately expected to vest is recognized as expense in the Company’s Unaudited Consolidated Statements of Operations over the requisite service periods. Share-based compensation expense recognized for the three and six months ended June 30, 2012 were $0.1 million for each period, and $0.1 million and $0.2 million for three and six months ended June 30, 2011, respectively, which was related to stock option grants and employee stock purchases.
 
Forfeitures are estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is determined at the end of each fiscal quarter, based on historical rates.
 
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.
 
Income Taxes
 
The Company accounts for income taxes using the liability method. Under the liability method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. The Company records liabilities, where appropriate, for all uncertain income tax positions. The Company recognizes interest and penalties related to unrecognized tax benefits within operations as income tax expense.


Comprehensive Income (Loss)
 
Other comprehensive income (loss) as of June 30, 2012 and December 31, 2011, consists of unrealized gains (losses) on marketable securities categorized as available-for-sale and foreign currency translation adjustments.
 
Net Income (Loss) per Common Share
 
Basic net income (loss) and diluted net income (loss) per share is calculated using the weighted average shares of common stock outstanding. Diluted net income per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding during the period, using the treasury stock method for stock options.
 
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 June 30, 2012 and December 31, 2011, all of the Company’s accounts receivable, intangible assets, and deferred revenue are 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 1, 2012, we adopted guidance issued by the Financial Accounting Standards Board (“FASB”) which requires companies to present net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. Adoption of this new guidance did not have a material impact on our financial statements.

On January 1, 2012, we adopted guidance issued by the FASB on accounting and disclosure requirements related to fair value measurements. The guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, the guidance expands the disclosures on Level 3 inputs by requiring quantitative disclosure of the unobservable inputs and assumptions, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. Adoption of this new guidance did not have a material impact on the Company’s consolidated financial statements.

Recent Accounting Pronouncements Not Yet Adopted

In December 2011, the FASB issued an amendment to an existing accounting standard which indefinitely defers the requirement to present components of reclassifications of other comprehensive income on the face of the income statement.

Subsequent Event

In July 2012, the Company entered into an agreement to sublease its office space in San Francisco under terms generally equivalent to its existing commitment.  The sublease commences in August 2012 and expires in December 2014. Beginning in August 2012, the Company plans to utilize a smaller space for its corporate office in San Francisco, California.

In July 2012, PEEK Investments, Inc. (PEEK) and other persons acting in concert with PEEK made an unsolicited proposal to acquire the Company and subsequently commenced a tender offer for all outstanding shares of common stock of the Company.  The Company’s Board of Directors carefully evaluated the proposal made by PEEK and, after consultation with its financial and legal advisors, unanimously determined that PEEK’s proposal was not in the best interests of the Company or its stockholders and recommended that stockholders reject the tender offer.  Responding to PEEK’s unsolicited tender offer may require the Company to incur significant additional costs.
 
 
2. Cash, Cash Equivalents and Short-Term Investments
 
The following table summarizes the Company’s cash and available-for-sale securities’ amortized cost and estimated fair value by significant investment category as of June 30, 2012 and December 31, 2011 (in thousands):
 
 
 
Amortized Cost and Estimated Fair Value
 
 
 
June 30,
   
December 31,
 
 
 
2012
   
2011
 
Cash and cash equivalents:
 
 
   
 
 
Cash
  $ 2,591     $ 7,205  
Cash equivalents
               
Money market mutual funds
    116       1,045  
Certificates of deposit
    1,500       3,100  
Commercial paper
    7,299       6,600  
Total cash equivalents
    8,915       10,745  
Total cash and cash equivalents
    11,506       17,950  
Short-term investments:
               
Corporate bonds
    2,544       2,031  
Certificates of deposit
    3,351       3,278  
Commercial paper
    2,799       1,500  
Total short-term investments
    8,694       6,809  
Total cash and available-for-sale securities
  $ 20,200     $ 24,759  

Realized gains and losses were not significant for either of the three and six months ended June 30, 2012 and 2011. As of June 30, 2012, and December 31, 2011, there were no significant unrealized gains or losses on investments. The cost of all securities sold is based on the specific identification method.
 
The contractual maturities of cash equivalents and short-term investments at June 30, 2012, and December 31, 2011, were less than one year.
 
The Company typically invests in highly-rated securities, and its policy generally limits the amount of credit exposure to any one issuer. When evaluating the investments for other-than-temporary impairment, the Company reviews such factors as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer, and the Company’s intent to sell, or whether it is more likely than not it will be required to sell the investment before recovery of the investment’s amortized cost basis. During the three and six months ended June 30, 2012 and 2011, the Company did not recognize any impairment charges on outstanding investments. As of June 30, 2012, 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 June 30, 2012 and December 31, 2011 (in thousands):
 
 
 
June 30, 2012
   
December 31, 2011
 
 
 
Cost
   
Accumulated Depreciation
   
Net Book
Value
   
Cost
   
Accumulated Depreciation
   
Net Book
Value
 
Computer equipment
  $ 9,998     $ (8,662 )   $ 1,336     $ 9,751     $ (8,002 )   $ 1,749  
Furniture and fixtures
    165       (72 )     93       75       (62 )     13  
Software
    1,241       (1,234 )     7       1,241       (1,229 )     12  
Leasehold improvements
    308       (170 )     138       308       (141 )     167  
Total
  $ 11,712     $ (10,138 )   $ 1,574     $ 11,375     $ (9,434 )   $ 1,941  
 
Depreciation expense on property and equipment for the three and six months ended June 30, 2012, including property and equipment under capital lease, was $0.3 million and $0.7 million, respectively, and is recorded in operating expenses. Depreciation expense on property and equipment for the three and six months ended June 30, 2011, including property and equipment under capital lease, was $0.4 million and $0.9 million, respectively. Equipment under capital lease totaled $1.1 million and $2.8 million as of June 30, 2012 and December 31, 2011, respectively. Depreciation expense on equipment under capital lease was $0.1 million and $0.2 million for the three and six months ended June 30, 2012, respectively, and was $0.3 million and $0.6 million for the three and six months ended June 30, 2011, respectively. Additionally, accumulated depreciation on equipment under capital lease was $0.9 million and $2.5 million as of June 30, 2012 and December 31, 2011, respectively.
 
 
4. Capitalized Software and Other Assets
 
The Company’s capitalized software and other assets are as follows at June 30, 2012 and December 31, 2011 (in thousands):
 
 
 
June 30, 2012
   
December 31, 2011
 
 
 
Gross
Amount
   
Accumulated Amortization
   
Net Book
Value
   
Gross
Amount
   
Accumulated Amortization
   
Net Book
Value
 
Capitalized software
  $ 6,806     $ (5,357 )   $ 1,449     $ 6,688     $ (5,503 )   $ 1,185  
Amortizable purchased technology
    78       (78 )     -       78       (78 )     -  
Other assets
    25       -       25       35       -       35  
    $ 6,909     $ (5,435 )   $ 1,474     $ 6,801     $ (5,581 )   $ 1,220  

Capitalized software consists of external direct costs of materials and services consumed in developing and obtaining internal-use computer software and the payroll and payroll-related costs for employees who are directly associated with, and who devote time to, developing the internal-use computer software and is amortized over three years. In the three and six months ended June 30, 2012, $0.3 million and $0.6 million, respectively, were added to active projects, as compared to $0.1 million and $0.2 million for the same periods in 2011, respectively. The Company had capitalized costs of $1 million and $0.5 million at June 30, 2012 and December 31, 2011, respectively, related to projects not yet placed into service. Amortization expense was $0.1 million and $0.4 million for the three and six months ended June 30, 2012, respectively, and was $0.3 million and $0.5 million for the three and six months ended June 30, 2011, respectively.
 
Fully amortized capitalized software of $0.5 million was determined to be obsolete and was written off in March 2012.
 
5. Accrued Liabilities
 
Accrued liabilities consisted of the following as of June 30, 2012 and December 31, 2011 (in thousands):
 
 
 
June 30,
   
December 31,
 
   
2012
   
2011
 
Accrued distribution and partner costs
  $ 720     $ 409  
Accrued compensation and related expenses
    259       137  
Accrued professional service fees
    127       257  
Other
    3       92  
Total accrued liabilities
  $ 1,109     $ 895  

6. Restructuring Charges
 
In 2011, the Company paid $0.9 million in pre-tax restructuring charges associated with the termination of employees. All restructuring charges have been classified as such on the Unaudited Consolidated Statement of Operations. The Company had no restructuring costs accrued at June 30, 2012 and December 31, 2011.
 
7. Capital Lease and Other Obligations
 
Capital lease and other obligations consist of the following at June 30, 2012 and December 31, 2011 (in thousands):
 
 
 
June 30,
   
December 31,
 
 
 
2012
   
2011
 
Capital lease obligations
  $ 313     $ 657  
Deferred rent
    140       154  
Total capital lease and other obligations
    453       811  
Less: current portion of capital lease obligations
    (313 )     (515 )
Capital lease and other obligations, net of current portion
  $ 140     $ 296  

Capital Lease Obligations
 
City National Bank
 
In April 2007, the Company entered into a master equipment lease agreement with CNB for an original amount of up to $5.0 million for the purchase of computer equipment. The lease expired on April 30, 2010, at which time the Company had drawn down approximately $4.9 million of the available lease line of credit. Interest on the capital leases was calculated using interest rates ranging from 4.32% to 7.95% per annum. In 2011, the master equipment lease agreement was amended to modify two financial covenants, with which the Company was in compliance as of June 30, 2012, and December 31, 2011.
 
The agreements with CNB, consisting of an outstanding standby letter of credit (“SBLC”) and a master equipment lease agreement, contain cross-default provisions, whereby a default under one is deemed a default for the other, and are secured by a general lien on all assets of the Company. As of June 30, 2012, and December 31, 2011, the Company was not in default on either agreement with CNB. For further discussion see Note 8, Commitments and Contingencies.
 
 
8. Commitments and Contingencies

As of June 30, 2012 future minimum payments under all capital and operating leases are as follows (in thousands):
 
 
 
CNB
Capital Lease
   
Operating
Leases
   
Total
 
Six months ending December 31, 2012
  $ 202     $ 404     $ 606  
Years ending December 31,
                       
2013
    111       690       801  
2014
    -       693       693  
2015
    -       81       81  
Total minimum payments
    313     $ 1,868     $ 2,181  
Less: amount representing interest
    -                  
Present value of net minimum payments
    313                  
Less: current portion
    (313 )                
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 office space in San Francisco under terms generally equivalent to its existing commitment.  The sublease commences in August 2012 and expires in December 2014. Beginning in August 2012, the Company plans to utilize a smaller space of approximately of 471 square feet for its corporate office in San Francisco, California.
 
The Company leases a sales office in New York, New York on a month to month basis.
 
The Company leases office space in Kitchener, Canada of approximately of 5,222 square feet. The lease has a constant term of six months.
 
The Company leases office space in Los Angeles, California of approximately of 4,803 square feet. The lease expires in July 2015.
 
Letters of Credit
 
As of June 30, 2012 and December 31, 2011, the Company has an outstanding SBLC related to the security of a building lease for $0.2 million. The SBLC contains two financial covenants, with which the Company was in compliance as of June 30, 2012.
 
The agreements with CNB, consisting of the SBLC and master equipment lease agreement, contain cross-default provisions, whereby a default under one is deemed a default for the other, and are secured by a general lien on all assets of the Company. As of June 30, 2012 and December 31, 2011, the Company was not in default on either agreement with CNB. For further discussion, see Note 7, Capital Lease and Other Obligations.
 
Purchase Obligations
 
The Company had outstanding purchase obligations of an insignificant amount relating to an open purchase order for which the Company had not received the related services or goods and a non-cancelable contractual obligation relating to IT data center operations as of June 30, 2012, and December 31, 2011.
 
Guarantees and Indemnities
 
During its normal course of business, the Company has made certain guarantees, indemnities and commitments under which it may be required to make payments in relation to certain transactions. These indemnities include intellectual property and other indemnities to the Company’s customers and distribution network partners in connection with the sales of its products, and indemnities to a lessor in connection with facility leases for certain claims arising from such facility or lease.
 
Officer and Director Indemnification
 
Further, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was, serving, at the Company’s request, in such capacity, to the maximum extent permitted under the laws of the State of Delaware. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. However, the Company maintains directors and officers insurance coverage that may contribute, up to certain limits, a portion of any future amounts paid, for indemnification of directors and officers. The Company believes the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal. Historically, the Company has not incurred any losses or recorded any liabilities related to performance under these types of indemnities.
 
Legal Proceedings
 
The Company is involved, from time to time, in various legal proceedings arising from the normal course of business activities. Although the results of litigation and claims cannot be predicted with certainty, the Company does not expect resolution of these matters to have a material adverse impact on its consolidated results of operations, cash flows or financial position unless stated otherwise. However, an unfavorable resolution of a matter could, depending on its amount and timing, materially affect its results of operations, cash flows or financial position in a future period. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense costs, diversion of management resources and other factors.

 
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 Company’s Plans are administered by the Compensation Committee of the Board of Directors. Awards under the Plans principally include at-the-money options and fully vested restricted stock. 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. The number of shares issued or reserved for issuance under the Plans was 4.1 million and 4.3 million shares of common stock as of June 30, 2012 and December 31, 2011, respectively. There were 1.8 million shares available to be granted under the 2007 Plan at June 30, 2012.
 
Share-based compensation expense recorded during three and six months ended June 30, 2012 and 2011 was included in the Company’s Unaudited Consolidated Statement of Operations as follows (in thousands):
 
 
 
Three Months Ended
   
Six Months Ended
 
 
 
June 30,
   
June 30,
 
 
 
2012
   
2011
   
2012
   
2011
 
Sales and marketing
  $ 6     $ 2     $ 17     $ 2  
Product development and technical operations
    17       42       27       86  
General and administrative
    31       46       77       77  
Total share-based compensation expense
    54       90       121       165  
Amounts capitalized as software development costs
    2       6       4       16  
Total share-based compensation
  $ 56     $ 96     $ 125     $ 181  
 
Total unrecognized share-based compensation expense related to share-based compensation arrangements at June 30, 2012 was $0.6 million and is expected to be recognized over a weighted-average period of approximately 3.0 years. The total fair value of equity awards vested during both the three and six months ended June 30, 2012 was $0.1 million, and $0.1 million, respectively, and $0.2 million during both the three and six months ended June 30, 2011.
 
Option Awards
 
Stock option activity under the Plans during the three and six months ended June 30, 2012 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, 2011
    2,662     $ 2.76    
 
   
 
 
Granted
    207       1.26    
 
   
 
 
Exercised
    (2 )     1.39    
 
   
 
 
Expired/forfeited
    (235 )     2.50    
 
   
 
 
Options outstanding at March 31, 2012
    2,632       2.64    
 
   
 
 
Granted
    213       0.83    
 
   
 
 
Exercised
    -       -    
 
   
 
 
Expired/forfeited
    (565 )     2.61    
 
   
 
 
Options outstanding at June 30, 2012
    2,280     $ 2.47       4.66     $ -  
Vested and expected to vest at June 30, 2012
    2,015     $ 2.63       4.42     $ -  
Exercisable at June 30, 2012
    1,322     $ 3.29       3.57     $ -  

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 June 30, 2012:
 
 
   
 
   
 
   
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)
   
 
 
$ 0.76       -     $ 1.19       396       3.45     $ 0.94       88     $ 1.07  
  1.21       -       1.84       1,148       4.27       1.53       524       1.50  
  1.86       -       2.83       193       3.86       2.46       167       2.55  
  2.91       -       4.45       374       3.42       3.52       374       3.52  
  4.46       -       7.35       59       2.43       5.35       59       5.35  
  7.75       -       20.55       110       1.61       13.40       110       13.40  
                          2,280       4.66       2.47       1,322       3.29  

Stock Awards
 
The Company did not issue restricted stock during the three and six months ended June 30, 2012 and 2011.The Company recorded no share-based compensation for stock awards for each of the three and six months ended June 30, 2012 and 2011.
 
Employee Stock Purchase Plan
 
On July 14, 2009, the 2009 Employee Stock Purchase Plan (the “2009 ESPP”) was approved by the shareholders. Under the 2009 ESPP, the Company is authorized to issue up to 500 thousand shares of Common Stock to employees of the Company. Under the 2009 ESPP, substantially all employees may purchase the Company’s common stock through payroll deductions at a price equal to 85 percent of the lower of the fair market value at the beginning of the offering period or at the end of each applicable purchase period. Each offering period is 6 months and consists of one purchase period. ESPP contributions are limited to a maximum of 15 percent of an employee’s eligible compensation, and ESPP participants are limited to purchasing a maximum of 5,000 shares per purchase period. Share-based compensation expense under the 2009 ESPP was insignificant for each of the three and six months ended June, 2012 and 2011. As of June 30, 2012, 69 thousand shares have been issued under the 2009 ESPP.
 
Share-Based Compensation Valuation Assumptions
 
The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option valuation model. The weighted average assumptions used in the Black-Scholes option valuation model and the weighted average grant date fair value per share for employee, consultant and director stock options were as follows:
 
 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
 
2012
   
2011
   
2012
   
2011
 
Volatility
    62.6 %     67.7 %     62.6 %     67.5 %
Risk-free interest rate
    0.68 %     1.47 %     0.78 %     1.50 %
Expected term (years)
    4.48       4.05       4.44       4.03  
Expected dividend yield
    -       -       -       -  
Weighted average grant date fair value
  $ 0.42     $ 0.93     $ 0.52     $ 0.92  
 
As share-based compensation expense recognized in the Unaudited Consolidated Statement of Operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
 
Exercise of Employee and Director Stock Options and Purchase Plans
 
There were no options exercised in the three months ended June 30, 2012, and 2 thousand options exercised in six months ended June 30, 2012. There were 5 thousand and 35 thousand options exercised in the three and six months ended June 30, 2011, respectively. The Company issues new shares of common stock upon exercise of stock options. No income tax benefits have been realized from exercised stock options.


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 June 30, 2012 and December 31, 2011 were as follows (in thousands):
 
 
 
Balance at
June 30, 2012
   
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
  $ 116     $ 116     $ -     $ -  
Certificates of deposit
    1,500       -       1,500       -  
Commercial paper
    7,299       -       7,299       -  
      8,915       116       8,799       -  
Short-term investments:
                               
Certificates of deposit
    3,351       -       3,351       -  
Corporate bonds
    2,544       -       2,544       -  
Commercial paper
    2,799       -       2,799       -  
      8,694       -       8,694       -  
                                 
Total financial assets measured at fair value
  $ 17,609     $ 116     $ 17,493     $ -  
 
   
Balance at
December 31, 2011
   
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
  $ 1,045     $ 1,045     $ -     $ -  
Certificates of deposit
    3,100       -       3,100       -  
Commercial paper
    6,600       -       6,600       -  
      10,745       1,045       9,700       -  
Short-term investments:
                               
Certificates of deposit
    3,278       -       3,278       -  
Corporate bonds
    2,031       -       2,031       -  
Commercial paper
    1,500       -       1,500       -  
      6,809       -       6,809       -  
                                 
Total financial assets measured at fair value
  $ 17,554     $ 1,045     $ 16,509     $ -  

Investments
 
For investments that have quoted market prices in active markets, the Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. The Company receives the quoted market prices from a third party, nationally recognized pricing service (“pricing service”). When quoted market prices are unavailable, the Company utilizes a pricing service to determine a single estimate of fair value, which is mainly for its fixed maturity investments. The fair value estimates provided from this pricing service are included in the amount disclosed in Level 2 of the hierarchy. The Company bases all of its estimates of fair value for assets on the bid price as it represents what a third party market participant would be willing to pay in an arm’s length transaction.
 
The Company validates the prices received from the pricing service using various methods including, applicability of Federal Deposit Insurance Corporation or other national government insurance or guarantees, comparison of proceeds received on individual investments subsequent to reporting date, prices received from publicly available sources, and review of transaction volume data to confirm the presence of active markets. The Company does not adjust the prices received from the pricing service unless such prices are determined to be inconsistent. At June 30, 2012 and December 31, 2011, the Company did not adjust prices received from the pricing service.


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 which the liability with short settlement periods would be transferred to a market participant with a similar credit standing as the Company.
 
11. Related Party Transactions
 
In each of the three and six months ended June 30, 2012 and 2011, Dr. Jean-Yves Dexmier was paid fees totaling $0.1 million and $0.2 million, respectively, in connection with his services as the Company’s Chief Executive Officer and Executive Chairman of the Board.
 
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, additional expenses to be incurred in connection with the unsolicited tender offer by PEEK, 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 Nasdaq, 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, 2011. As of June 30, 2012, there had been no material changes to our critical accounting policies and estimates.
 
Business Overview
 
LookSmart, Ltd. (“LookSmart” or “the Company”) is an advertising network solutions company that provides relevant solutions for search and display advertising customers. LookSmart was organized in 1996 and is incorporated in the State of Delaware.
 
LookSmart operates in a large online search and display advertising ecosystem serving ads on partner sites. In search advertising 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 search advertising customers are generally of three types; Intermediaries, Direct Advertisers and Self-Service Advertisers. Intermediaries purchase clicks to sell into the affiliate networks of the large search engine providers. Direct Advertisers and their agencies purchase clicks with the assistance of LookSmart account managers to achieve conversions or sales from the clicks or to obtain unique page views. Self-Service Advertisers are small Direct Advertisers that sign-up online, pay by credit card and manage their account with minimal LookSmart account management assistance.
 
In display advertising, our customers purchase display advertising which we fulfill and deliver via relationships with third party providers.
 
LookSmart offers search advertising customers targeted search via a monitored search advertising distribution network using the Company’s “AdCenter” platform technology. The Company’s search advertising network includes publishers and search advertising customers, including Intermediaries and direct advertising customers and their agencies as well as self-service customers in the United States and certain other countries. The Company’s application programming interface (“API”) allows search advertising customers and their advertising agencies to connect any type of marketing or reporting software with minimal effort, for easier access, management, and optimization of search advertising campaigns.
 
LookSmart also offers publishers licensed private-label search advertiser network solutions based on its AdCenter platform technology (“Publisher Solutions”). Publisher Solutions consist of hosted auction-based ad serving with an ad backfill capability that allows publishers and portals to manage their advertiser relationships, distribution channels and accounts.


In 2011, revenue from Intermediaries decreased significantly. The decrease was primary driven by a revenue decrease throughout the year, including a significant decrease in the fourth quarter due to revenue chargebacks to our Intermediary customers by large search engine providers. This had a severe impact to Intermediary business models and consequently the business they conduct with us. We have ceased business with several Intermediaries as a result and we do not expect significant future revenue or growth in the Intermediary business. Our future revenue and growth will come largely from Direct Advertisers, Self-Service Advertisers and other digital advertising models we may consider.
 
In July 2012, PEEK Investments, Inc. (PEEK) and other persons acting in concert with PEEK made an unsolicited proposal to acquire the Company and subsequently commenced a tender offer for all outstanding shares of common stock of the Company.  The Company’s Board of Directors carefully evaluated the proposal made by PEEK and, after consultation with its financial and legal advisors, unanimously determined that PEEK’s proposal was not in the best interests of the Company or its stockholders and recommended that stockholders reject the tender offer.  Responding to PEEK’s unsolicited tender offer may require the Company to incur significant additional costs.
 
Results of Operations
 
Overview of the Three and Six Months Ended June 30, 2012 and 2011
 
The following tables set forth selected information concerning our results of operations for the periods indicated (in thousands):
 
 
 
Three Months Ended June 30,
 
 
 
2012
   
% of
Revenue
   
2011
   
% of
Revenue
   
Dollar
Change
   
%
Change
 
Revenue
  $ 3,574       100.0 %   $ 6,605       100.0 %   $ (3,031 )     (46 %)
Cost of revenue
    2,370       66.3 %     3,439       52.1 %     (1,069 )     (31 %)
Gross profit
    1,204       33.7 %     3,166       47.9 %     (1,962 )     (62 %)
Operating expenses:
                                               
Sales and marketing
    753       21.1 %     558       8.4 %     195       35 %
Product development and technical operations
    1,555       43.5 %     1,550       23.5 %     5       0.3 %
General and administrative
    1,264       35.4 %     1,037       15.7 %     227       22 %
Total operating expenses
    3,572       100.0 %     3,145       47.6 %     427       14 %
Income (loss) from operations
    (2,368 )     (66.4 %)     21       0.3 %     (2,389 )     (11376 %)
Non-operating income (expense), net
    9       0.3 %     333       5.0 %     (324 )     (97 %)
Income (loss) from continuing operations before income taxes
    (2,359 )     (66.1 %)     354       5.3 %     (2,713 )     (766 %)
Income tax benefit
    -       -       -       -       -          
Net income (loss)
  $ (2,359 )     (66.1 %)   $ 354       5.3 %   $ (2,713 )     (766 %)

   
Six Months Ended June 30,
 
   
2012
   
% of
Revenue
   
2011
   
% of
Revenue
   
Dollar
Change
   
%
Change
 
Revenue
  $ 7,587       100.0 %   $ 14,994       100.0 %   $ (7,407 )     (49 %)
Cost of revenue
    4,585       60.4 %     8,094       54.0 %     (3,509 )     (43 %)
Gross profit
    3,002       39.6 %     6,900       46.0 %     (3,898 )     (56 %)
Operating expenses:
                                               
Sales and marketing
    1,459       19.2 %     1,167       7.8 %     292       25 %
Product development and technical operations
    3,343       44.1 %     3,144       21.0 %     199       6.3 %
General and administrative
    2,725       35.9 %     2,462       16.4 %     263       11 %
Restructuring charge
    -       -       889       5.9 %     (889 )     (100 %)
Total operating expenses
    7,527       99.2 %     7,662       51.1 %     (135 )     (2 %)
Loss from operations
    (4,525 )     (59.6 %)     (762 )     (5.1 %)     (3,763 )     494 %
Non-operating income (expense), net
    16       0.2 %     320       2.1 %     (304 )     (95 %)
Loss from continuing operations before income taxes
    (4,509 )     (59.4 %)     (442 )     (3.0 %)     (4,067 )     920 %
Income tax benefit
    -       -       1       -       (1 )     (100 %)
Net loss
  $ (4,509 )     (59.4 %)   $ (441 )     (3.0 %)   $ (4,068 )     922 %
 
 
Revenue
 
Revenue is derived from two service offerings or “products” of LookSmart Ltd. (the “Company”): Advertiser Networks and Publisher Solutions. Total revenue and revenue from Advertiser Networks and Publisher Solutions for the three and six months ended June 30, 2012 and 2011, were as follows (in thousands):
 
 
 
Three Months Ended June 30,
 
 
 
2012
   
% of
Revenue
   
2011
   
% of
Revenue
   
Dollar
Change
   
%
Change
 
Advertiser Networks
  $ 3,301       92 %   $ 6,313       96 %   $ (3,012 )     (48 %)
Publisher Solutions
    273       8 %     292       4 %     (19 )     (7 %)
Total revenue
  $ 3,574       100 %   $ 6,605       100 %   $ (3,031 )     (46 %)

 
 
Six Months Ended June 30,
 
 
 
2012
   
% of
Revenue
   
2011
   
% of
Revenue
   
Dollar
Change
   
%
Change
 
Advertiser Networks
  $ 6,950       92 %   $ 14,460       96 %   $ (7,510 )     (52 %)
Publisher Solutions
    637       8 %     534       4 %     103       19 %
Total revenue
  $ 7,587       100 %   $ 14,994       100 %   $ (7,407 )     (49 %)

Advertiser Networks
 
The decrease in Advertiser Networks revenue for the three months and six months ended June 30, 2012, as compared to the same periods in 2011 is substantially the result of a loss of Intermediary business. We experienced a reduction in Intermediary revenue throughout 2011 and a significant decrease in revenue from Intermediaries in the fourth quarter due to revenue chargebacks to our customers by large search engine providers. This had a severe impact to Intermediary business models and consequently the business they conduct with us. We have ceased business with several Intermediaries as a result and we do not expect significant future revenue or growth in Intermediary business. Our future revenue and growth will come largely from Direct Advertisers, Self-Service Advertisers and other digital advertising models we may consider.
 
Publisher Solutions
 
Publisher Solutions revenues were lower in the three months ended June 30, 2012, compared to the same period in 2011 due to seasonal platform volume by one licensee combined with a reduction in a volume by another. Publisher Solutions revenues were higher in the six months ended June 30, 2012, compared to the six months ended June 30, 2011, due to additions to licensees and higher transaction volumes in the first quarter of 2012 as compared to the first quarter of 2011.
 
Cost of Revenue and Gross Margin
 
Cost of revenue, consisting of TAC which are amounts paid to our distribution network partners, connectivity costs, hosting expenses, commissions paid to advertising agencies, and credit card fees were as follows for the three and six months ended June 30, 2012 and 2011 (in thousands):
 
 
 
Three Months Ended June 30,
 
 
 
2012
   
% of
Revenue
   
2011
   
% of
Revenue
   
Dollar
Change
   
%
Change
 
Traffic acquisition costs
  $ 2,019       56 %   $ 3,044       46 %   $ (1,025 )     (34 %)
Other costs
    351       10 %     395       6 %     (44 )     (11 %)
Total cost of revenue
  $ 2,370       66 %   $ 3,439       52 %   $ (1,069 )     (31 %)

 
 
Six Months Ended June 30,
 
 
 
2012
   
% of
Revenue
   
2011
   
% of
Revenue
   
Dollar
Change
   
%
Change
 
Traffic acquisition costs
  $ 3,870       51 %   $ 7,303       49 %   $ (3,433 )     (47 %)
Other costs
    715       9 %     791       5 %     (76 )     (10 %)
Total cost of revenue
  $ 4,585       60 %   $ 8,094       54 %   $ (3,509 )     (43 %)

TAC as a percent of associated revenue increased in the three and six months ended June 30, 2012, when compared to the three and six months ended June 30, 2011. This increase is due to higher TAC on Intermediary business in 2012 as compared to 2011.
 
Our other costs of revenue, which consist of network operating costs and credit card processing fees, decreased due to the decrease in revenue.
 
 
Operating Expenses
 
Operating expenses for the three and six months ended June 30, 2012, as compared to the same period in 2011 increased by $0.4 million and decreased $0.1 million, respectively. Operating expense for the six months ended June 30, 2011, included a $0.9 million restructuring charge for a reduction in workforce in that period. Excluding the effect of that 2011 restructuring charge, operating expenses increased by $0.8 million in the first half a year of 2012, compared to the first half a year of 2011.
 
Operating expenses consist of sales and marketing, product development and technical operations, general and administrative, and restructuring charges for the three and six months ended June 30, 2012 and 2011, and were as follows (in thousands):
 
 
 
Three Months Ended June 30,
 
 
 
2012
   
% of
Revenue
   
2011
   
% of
Revenue
   
Dollar
Change
   
%
Change
 
Sales and marketing
  $ 753       21 %   $ 558       8 %   $ 195       35 %
Product development and technical operations
    1,555       44 %     1,550       24 %     5       0 %
General and administrative
    1,264       35 %     1,037       16 %     227       22 %
Total operating expenses
  $ 3,572       100 %   $ 3,145       48 %   $ 427       14 %

 
 
Six Months Ended June 30,
 
 
 
2012
   
% of
Revenue
   
2011
   
% of
Revenue
   
Dollar
Change
   
%
Change
 
Sales and marketing
  $ 1,459       19 %   $ 1,167       8 %   $ 292       25 %
Product development and technical operations
    3,343       44 %     3,144       21 %     199       6 %
General and administrative
    2,725       36 %     2,462       16 %     263       11 %
Restructuring charge
    -       0 %     889       6 %     (889 )     (100 %)
Total operating expenses
  $ 7,527       99 %   $ 7,662       51 %   $ (135 )