form10q.htm

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, 2012, and December 31, 2011 (in thousands):

	Amortized Cost and Estimated Fair Value
	September 30,		December 31,
	2012		2011
Cash and cash equivalents:
Cash	$	1,016	$	7,205
Cash equivalents
Money market mutual funds		140		1,045
Certificates of deposit		1,500		3,100
Commercial paper		3,850		6,600
Total cash equivalents		5,490		10,745
Total cash and cash equivalents		6,506		17,950
Short-term investments:
Corporate bonds		2,520		2,031
Certificates of deposit		3,402		3,278
Commercial paper		5,196		1,500
Total short-term investments		11,118		6,809
Total cash, and cash equivalents, and short-term investments	$	17,624	$	24,759

Realized gains and losses were not significant for either of the three and nine months ended September 30, 2012 and 2011. As of September 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 September 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 nine months ended September 30, 2012 and 2011, the Company did not recognize any impairment charges on outstanding investments. As of September 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 September 30, 2012, and December 31, 2011 (in thousands):

	September 30, 2012							December 31, 2011
	Cost		Accumulated Depreciation			Net Book Value		Cost		Accumulated Depreciation			Net Book Value
Computer equipment	$	9,852	$	(8,940	)	$	912	$	9,751	$	(8,002	)	$	1,749
Furniture and fixtures		167		(76	)		91		75		(62	)		13
Software		1,452		(1,283	)		169		1,241		(1,229	)		12
Leasehold improvements		28		(21	)		7		308		(141	)		167
Total	$	11,499	$	(10,320	)	$	1,179	$	11,375	$	(9,434	)	$	1,941

Depreciation expense on property and equipment for the three and nine months ended September 30, 2012, including property and equipment under capital lease, 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, 2011, including property and equipment under capital lease, was $0.4 million and $1.3 million, respectively. Equipment under capital lease totaled $0.9 million and $2.8 million as of September 30, 2012 and December 31, 2011, respectively. Depreciation expense on equipment under capital lease was $0.1 million and $0.3 million for the three and nine months ended September 30, 2012, respectively, and was $0.2 million and $0.8 million for the three and nine months ended September 30, 2011, respectively. Additionally, accumulated depreciation on equipment under capital lease was $0.7 million and $2.5 million as of September 30, 2012, and December 31, 2011, respectively. As a result of the San Francisco office lease abandonment the Leasehold Improvements were no longer in use and as such were written off in the amount of $0.2 million in the third quarter of 2012 (see Note 3 for more information).

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4.	Capitalized Software and Other Assets

The Company’s capitalized software and other assets are as follows at September 30, 2012, and December 31, 2011 (in thousands):

	September 30, 2012							December 31, 2011
	Gross Amount		Accumulated Amortization			Net Book Value		Gross Amount		Accumulated Amortization			Net Book Value
Capitalized software	$	7,144	$	(5,503	)	$	1,641	$	6,688	$	(5,503	)	$	1,185
Amortizable purchased technology		78		(78	)		-		78		(78	)		-
Other assets		47		-			47		35		-			35
Deferred lease incentive		96		-			96		-		-			-
	$	7,365	$	(5,581	)	$	1,784	$	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 nine months ended September 30, 2012, $0.3 million and $1.0 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 $1.4 million and $0.5 million at September 30, 2012 and December 31, 2011, respectively, related to projects not yet placed into service. Amortization expense was $0.1 million and $0.5 million for the three and nine months ended September 30, 2012, respectively, and was $0.3 million and $0.5 million for the three and nine months ended September 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 September 30, 2012, and December 31, 2011 (in thousands):

	September 30,		December 31,
	2012		2011
Accrued distribution and partner costs	$	825	$	409
Accrued compensation and related expenses		243		137
Accrued professional service fees		139		257
Other		-		92
Total accrued liabilities	$	1,207	$	895

6.	Restructuring Charges

The Company had $0.2 million in restructuring costs associated with the sub-lease of the San Francisco headquarters during the three months ended September 30, 2012. During the nine months ended September 30, 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 accrued restructuring charges at September 30, 2012 or December 31, 2011.

7.	Capital Lease and Other Obligations

Capital lease and other obligations consist of the following at September 30, 2012, and December 31, 2011 (in thousands):

	September 30,			December 31,
	2012			2011
Capital lease obligations	$	208		$	657
Deferred rent		150			154
Total capital lease and other obligations		358			811
Less: current portion of capital lease obligations		(208	)		(515	)
Capital lease and other obligations, net of current portion	$	150		$	296

Capital Lease Obligations

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 September 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 September 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.

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8.	Commitments and Contingencies

As of September 30, 2012, future minimum payments under all capital and operating leases are as follows (in thousands):

	CNB Capital Lease			Operating Leases		Total
Three months ending December 31, 2012	$	101		$	43	$	144
Years ending December 31,
2013		111			41		152
2014		-			15		15
2015		-			81		81
Total minimum payments		212		$	180	$	392
Less amount representing interest		(4	)
Present value of net minimum payments		208
Less: current portion		(208	)
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. Accordingly, beginning in August 2012, the Company has utilized a smaller space 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 September 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 September 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 September 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 September 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

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.

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Unsolicited Tender Offer

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. As extended, the tender offer is scheduled to expire on November 30, 2012.

As more fully described in the Company’s Solicitation/Recommendation on Schedule 14D-9 filed with the SEC on August 2, 2012, as amended, in response to the offer, the Company’s Board of Directors unanimously recommended that the Company’s stockholders reject the offer and not tender their shares to PEEK for purchase. The Company is currently engaged in discussion with PEEK with respect to possible board representation rights and related agreements and transactions. However, the Company cannot guarantee that the negotiations will result in any agreement between the Company and PEEK. Responding to PEEK’s unsolicited tender offer resulted in the Company incurring significant additional legal and other advisory costs with respect to the tender offer and the Company may incur additional such expenses in the future.

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 September 30, 2012 and December 31, 2011, respectively. There were 1.7 million shares available to be granted under the 2007 Plan at September 30, 2012.

Share-based compensation expense recorded during three and nine months ended September 30, 2012, and 2011 was included in the Company’s Unaudited Consolidated Statements of Operations as follows (in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
Sales and marketing	$	6	$	10	$	23	$	12
Product development and technical operations		13		47		41		131
General and administrative		29		41		106		120
Total share-based compensation expense		48		98		170		263
Amounts capitalized as software development costs		8		3		12		19
Total share-based compensation	$	56	$	101	$	182	$	282

Total unrecognized share-based compensation expense related to share-based compensation arrangements at September 30, 2012 was $0.6 million and is expected to be recognized over a weighted-average period of approximately 2.8 years. The total fair value of equity awards vested during the three and nine months ended September 30, 2012 was $0.1 million, and $0.2 million, respectively, and $0.1 million and $0.3 million during the three and nine months ended September 30, 2011, respectively.

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Option Awards

Stock option activity under the Plans during the nine months ended September 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
Granted		107			0.91
Exercised		-			-
Expired/forfeited		(104	)		1.84
Options outstanding at September 30, 2012		2,283		$	2.43		4.52	$	-
Vested and expected to vest at September 30, 2012		2,035		$	2.58		4.30	$	-
Exercisable at September 30, 2012		1,353		$	3.21		3.50	$	-

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, 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		473		6.01	$	0.94		101	$	1.06
	1.23	-		1.86		1,106		4.90		1.53		562		1.51
	1.88	-		2.83		175		3.84		2.52		161		2.58
	2.91	-		4.45		366		3.21		3.51		366		3.51
	4.46	-		7.35		54		2.30		5.37		54		5.37
	7.75	-		20.55		109		0.74		13.43		109		13.43
						2,283		4.52		2.43		1,353		3.21

Stock Awards

The Company did not issue restricted stock during the three and nine months ended September 30, 2012 and 2011.The Company recorded no share-based compensation for stock awards for each of the three and nine months ended September 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 nine months ended September 30, 2012 and 2011. As of September 30, 2012, 82 thousand shares have been issued under the 2009 ESPP.

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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 September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Volatility		62.6	%		64.8	%		62.6	%		67.0	%
Risk-free interest rate		0.61	%		1.14	%		0.74	%		1.43	%
Expected term (years)		4.48			4.48			4.40			4.12
Expected dividend yield		-			-			-			-
Weighted average grant date fair value	$	0.45		$	0.76		$	0.51		$	0.88

As share-based compensation expense recognized in the Unaudited Consolidated Statements 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 September 30, 2012, and 2 thousand options exercised in nine months ended September 30, 2012. There were 7 thousand and 42 thousand options exercised in the three and nine months ended September 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.

Stockholder Rights Agreement

On August 23, 2012 the Company adopted a Stockholders Rights Agreement (the “Rights Agreement”). Pursuant to the Rights Agreement, each share of common stock of the Company is now associated with one preferred stock purchase right. Each right entitles stockholders to buy a unit representing one one-thousandth of a share of Series A Participating Preferred Stock of the Company for $5.00. Under certain circumstances, if a person or group acquires beneficial ownership of 15% or more of the Company's common stock, each right (other than rights held by the acquiror) will, unless the rights are redeemed by the Company, become exercisable upon payment of the exercise price.. Each one one-thousandth of a Preferred Share has designations and powers, preferences and rights, and the qualifications, limitations and restrictions designed to make it the economic equivalent of one share of the Company’s common stock.

Share Repurchases

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 amount and timing of the purchases will depend on a number of factors including the price and availability of the Company's common shares, trading volume and general market conditions. The Company may also from time to time establish a trading plan under Rule 10b5-1 of the Securities Exchange Act of 1934 to facilitate purchases of its common shares under this authorization. From May 31, 2012 through September 30, 2012, the Company repurchased approximately 40 thousand shares of its common stock under the share repurchase program announced in May 2012 at an average price of $0.84 per share for a total of 34 thousand dollars.

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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, 2012, and December 31, 2011 were as follows (in thousands):

	Balance at September 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	$	140	$	140	$	-	$	-
Certificates of deposit		1,500		-		1,500		-
Commercial paper		3,850		-		3,850		-
Total cash equivalents		5,490		140		5,350		-
Short-term investments:
Certificates of deposit		3,402		-		3,402		-
Corporate bonds		2,520		-		2,520		-
Commercial paper		5,196		-		5,196		-
Total short-term investments		11,118		-		11,118		-

Total financial assets measured at fair value	$	16,608	$	140	$	16,468	$	-

	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		-
Total cash equivalents		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		-
Total short-term investments		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 September 30, 2012 and December 31, 2011, the Company did not adjust prices received from the pricing service.

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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 nine months ended September 30, 2012 and 2011, Dr. Jean-Yves Dexmier was paid fees totaling $0.1 million and $0.4 million, respectively, in connection with his services as the Company’s Chief Executive Officer and Board member.

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, 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 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, 2011. As of September 30, 2012, there had been no material changes to our critical accounting policies and estimates.

Business Overview

LookSmart, Ltd. (“LookSmart” or the “Company”) is a digital advertising solutions company that provides relevant solutions for search and display advertising. LookSmart was organized in 1996 and is incorporated in the State of Delaware.

LookSmart provides advertisers with search marketing and display advertising solutions, and offers publishers the ability to monetize their inventory through our search network:

Search Advertisers: LookSmart search marketing network acquires queries from a large variety of sources and matches them with the keywords of our 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.

Display Advertisers: LookSmart also offers advertisers the ability to buy graphical display advertising. LookSmart’s trading desk personnel utilizes DSP technology and licensed data from third party providers to buy 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.

For Publishers: 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.

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In 2011, revenue from Intermediaries decreased significantly. The decrease was primarily driven by a revenue decrease throughout the year, including a significant decrease in the fourth quarter of 2011 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 ceased business with several Intermediaries as a result; however beginning in the second quarter of 2012, our Intermediary business and associated revenue began to increase. Intermediary revenue has increased to the point that it is currently the largest component of our overall revenue. We expect Intermediary revenue will continue to be the largest component of our revenue for the foreseeable future.

Unsolicited Tender Offer

As more fully described in the Company’s Solicitation/Recommendation on Schedule 14D-9 filed with the SEC on August 2, 2012, as amended, in response to the offer, the Company’s Board of Directors unanimously recommended that the Company’s stockholders reject the offer and not tender their shares to PEEK for purchase. We are currently engaged in discussion with PEEK with respect to possible board representation rights and related agreements and transactions. However, the Company cannot guarantee that the negotiations will result in any agreement between the Company and PEEK. Responding to PEEK’s unsolicited tender offer resulted in the Company incurring significant additional legal and other advisory costs with respect to the tender offer and the Company may incur additional such expenses in the future. In relation to the tender offer, we have recorded $0.6 million in expenses during the three months ended September 30, 2012, consisting primarily of legal, advisory, and other professional services fees.

Results of Operations

Overview of the Three and Nine Months Ended September 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 September 30,
	2012			% of Revenue			2011			% of Revenue			Dollar Change			% Change
Revenue	$	3,915			100.0	%	$	7,356			100.0	%	$	(3,441	)		(47	%)
Cost of revenue		2,564			65.5	%		4,187			56.9	%		(1,623	)		(39	%)
Gross profit		1,351			34.5	%		3,169			43.1	%		(1,818	)		(57	%)
Operating expenses:
Sales and marketing		682			17.4	%		565			7.7	%		117			21	%
Product development and technical operations		1,437			36.7	%		1,767			24.0	%		(330	)		(19	%)
General and administrative		1,743			44.5	%		1,066			14.5	%		677			64	%
Restructuring charge		159			4.1	%		-			0.0	%		159			100	%
Total operating expenses		4,021			102.7	%		3,398			46.2	%		623			18	%
Loss from operations		(2,670	)		(68.2	%)		(229	)		(3.1	%)		(2,441	)		1066	%
Non-operating income, net		16			0.4	%		9			0.1	%		7			78	%
Loss from continuing operations before income taxes		(2,654	)		(67.8	%)		(220	)		(3.0	%)		(2,434	)		1106	%
Income tax expense		-			-			(4	)		(0.1	%)		4			100	%
Net loss	$	(2,654	)		(67.8	%)	$	(224	)		(3.1	%)	$	(2,430	)		1085	%

	Nine Months Ended September 30,
	2012			% of Revenue			2011			% of Revenue			Dollar Change			% Change
Revenue	$	11,502			100.0	%	$	22,350			100.0	%	$	(10,848	)		(49	%)
Cost of revenue		7,149			62.2	%		12,281			54.9	%		(5,132	)		(42	%)
Gross profit		4,353			37.8	%		10,069			45.1	%		(5,716	)		(57	%)
Operating expenses:
Sales and marketing		2,141			18.6	%		1,732			7.7	%		409			24	%
Product development and technical operations		4,780			42	%		4,911			22.0	%		(131	)		(3	%)
General and administrative		4,468			38.8	%		3,528			15.8	%		940			27	%
Restructuring charge		159			1	%		889			4.0	%		(730	)		(82	%)
Total operating expenses		11,548			100.4	%		11,060			49.5	%		488			4	%
Loss from operations		(7,195	)		(62.6	%)		(991	)		(4.4	%)		(6,204	)		626	%
Non-operating income, net		32			0.3	%		329			1.5	%		(297	)		(90	%)
Loss from continuing operations before income taxes		(7,163	)		(62.3	%)		(662	)		(2.9	%)		(6,501	)		982	%
Income tax expense		-			-			(3	)		-			3			(100	%)
Net loss	$	(7,163	)		(62.3	%)	$	(665	)		(2.9	%)	$	(6,498	)		977	%

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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, 2012, and 2011, were as follows (in thousands):

	Three Months Ended September 30,
	2012		% of Revenue			2011		% of Revenue			Dollar Change			% Change
Advertiser Networks	$	3,676		94	%	$	7,043		96	%	$	(3,367	)		(48	%)
Publisher Solutions		239		6	%		313		4	%		(74	)		(24	%)
Total revenue	$	3,915		100	%	$	7,356		100	%	$	(3,441	)		(47	%)

	Nine Months Ended September 30,
	2012		% of Revenue			2011		% of Revenue			Dollar Change			% Change
Advertiser Networks	$	10,626		92	%	$	21,504		96	%	$	(10,878	)		(51	%)
Publisher Solutions		876		8	%		846		4	%		30			4	%
Total revenue	$	11,502		100	%	$	22,350		100	%	$	(10,848	)		(49	%)

Advertiser Networks

The decrease in Advertiser Networks revenue for the three months and nine months ended September 30, 2012, as compared to the same periods in 2011 is the result of a reduction in revenues from Intermediaries, Direct Advertisers and Self Service Advertisers. We experienced a large reduction in Intermediary revenue throughout 2011 and a significant decrease in revenue from Intermediaries in the fourth quarter of 2011due 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; however, beginning in the second quarter of 2012, our Intermediary business and associated revenue began to increase. Intermediary revenue has increased to the point that it is currently the largest component of our overall revenue, although our overall revenue for Advertisers Networks has continued to decrease. We expect Intermediary revenue will continue to be the largest component of our revenue for the foreseeable future.

Publisher Solutions

Publisher Solutions revenues were lower in the three months ended September 30, 2012, compared to the same period in 2011 due to volume reductions by licensees. Publisher Solutions revenues were higher in the nine months ended September 30, 2012, compared to the nine months ended September 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 nine months ended September 30, 2012, and 2011 (in thousands):

	Three Months Ended September 30,
	2012		% of Revenue			2011		% of Revenue			Dollar Change			% Change
Traffic acquisition costs	$	2,196		56	%	$	3,803		52	%	$	(1,607	)		(42	%)
Other costs		368		9	%		384		5	%		(16	)		(4	%)
Total cost of revenue	$	2,564		65	%	$	4,187		57	%	$	(1,623	)		(39	%)

	Nine Months Ended September 30,
	2012		% of Revenue			2011		% of Revenue			Dollar Change			% Change
Traffic acquisition costs	$	6,066		53	%	$	11,106		50	%	$	(5,040	)		(45	%)
Other costs		1,083		9	%		1,175		5	%		(92	)		(8	%)
Total cost of revenue	$	7,149		62	%	$	12,281		55	%	$	(5,132	)		(42	%)

TAC as a percent of Advertisers Network revenue increased in the three and nine months ended September 30, 2012, when compared to the three and nine months ended September 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.

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Operating Expenses

Operating expenses for the three and nine months ended September 30, 2012, as compared to the same period in 2011, increased by $0.6 million and $0.5 million, respectively. Operating expense for the three months ended September 30, 2012 included $0.6 million related to the unsolicited tender offer by PEEK and a $0.2 million restructuring charge for the sublease of the San Francisco headquarters. Operating expense for the nine months ended September 30, 2011, included a $0.9 million restructuring charge for a reduction in workforce in that period. Excluding the effect of those tender offer and restructuring charges, operating expenses decreased by $0.1 million in the three months ended September 30, 2012, compared to the three months ended September 30, 2011, and increased by $0.6 million in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. Responding to PEEK’s unsolicited tender offer resulted in the Company incurring significant additional legal and other advisory costs with respect to the tender offer and the Company may incur additional such expenses in the future. In relation to the PEEK tender offer, we have recorded $0.6 million in expenses during the three months ended September 30, 2012, consisting primarily of legal, advisory, and other professional services fees. 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, 2012, and 2011, and were as follows (in thousands):

	Three Months Ended September 30,
	2012		% of Revenue			2011		% of Revenue			Dollar Change			% Change
Sales and marketing	$	682		17	%	$	565		8	%	$	117			21	%
Product development and technical operations		1,437		37	%		1,767		24	%		(330	)		(19	%)
General and administrative		1,743		45	%		1,066		14	%		677			64	%
Restructuring charge		159		4	%		-		0	%		159			100	%
Total operating expenses	$	4,021		103	%	$	3,398		46	%	$	623			18	%

	Nine Months Ended September 30,
	2012		% of Revenue			2011		% of Revenue			Dollar Change			% Change
Sales and marketing	$	2,141		19	%	$	1,732		7	%	$	409			24	%
Product development and technical operations		4,780		41	%		4,911		22	%		(131	)		(3	%)
General and administrative		4,468		39	%		3,528		16	%		940			27	%
Restructuring charge		159		1	%		889		4	%		(730	)		(82	%)
Total operating expenses	$	11,548		100	%	$	11,060		49	%	$	488			4	%

Sales and Marketing

Sales and marketing expenses include salaries, commissions, share-based compensation and other costs of employment for our sales force, sales administration and customer service staff and marketing personnel, overhead, facilities 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, 2012, is primarily due to higher compensation related expense associated with increased headcount.

Product Development and Technical Operations

Product development and technical operations expense includes all costs related to the continued operations, development and enhancement of our core technology product, the AdCenter platform. The AdCenter is used to operate both our own Advertiser Network and other publishers’ client networks, and is licensed to publishers to operate their own network. These costs include salaries and associated costs of employment, including share-based compensation, overhead, and facilities. Costs related to the development of software for internal use in the business, including salaries and associated costs of employment are capitalized after certain milestones have been achieved and amortized over a three year period once the project is placed in service. Software licensing and computer equipment depreciation related to supporting product development and technical operations functions are also included in product development and technical operations expense.

Capitalized software development costs include the costs to develop software for internal use, excluding costs associated with research, training and testing.

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Product development and technical operations and capitalized software development costs for the three and nine months ended September 30, 2012, and 2011, were as follows (in thousands):

	Three Months Ended September 30,
	2012			% of Revenue			2011			% of Revenue			Dollar Change			% Change
Product development and technical operations costs	$	1,775			45	%	$	1,853			25	%	$	(78	)		(4	%)
Capitalized software development costs		(338	)		(8	%)		(86	)		(1	%)		(252	)		293	%
Total product development and technical operations expense	$	1,437			37	%	$	1,767			24	%	$	(330	)		(19	%)

	Nine Months Ended September 30,
	2012			% of Revenue			2011			% of Revenue			Dollar Change			% Change
Product development and technical operations costs	$	5,743			50	%	$	5,260			24	%	$	483			9	%
Capitalized software development costs		(963	)		(8	%)		(349	)		(2	%)		(614	)		(176	%)
Total product development and technical operations expense	$	4,780			42	%	$	4,911			22	%	$	(131	)		(3	%)

The decrease in product development and technical operations expense, net of capitalized software development costs for the three and nine months ended September 30, 2012, is primarily due to decreased travel costs.

General and Administrative

General and administrative expenses include costs of executive management, human resources, finance, facilities, and desktop support personnel. These costs include salaries and associated costs of employment, including share-based compensation, overhead, facilities and allocation of depreciation. General and administrative expenses also include legal, insurance, tax and accounting, consulting, professional services fees and the provision for, and reductions of, the allowance for doubtful trade receivables.

The increase in general and administrative expenses for the three and nine months ended September 30, 2012, is primarily due to costs of $0.6 million related to the unsolicited tender offer by PEEK and a $0.2 million restructuring charge for the sublease of the San Francisco headquarters.

Restructuring Charges

The Company entered into an agreement to sublease its office space in San Francisco under terms generally equivalent to its existing commitment. The Company had $0.2 million in restructuring costs associated with the sub-lease of the San Francisco headquarters in the three and nine months ended September 30, 2012. The Company had $0.9 million in restructuring costs associated with the reduction of its headcount in the nine months ended September 30, 2011.

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Other Items

The tables below set forth other continuing operations data for the three and nine months ended September 30, 2012, and 2011 (in thousands):

	Three Months Ended September 30,
	2012			% of Revenue			2011			% of Revenue			Dollar Change		% Change
Non-operating income (expense), net
Interest income	$	23			0	%	$	21			0	%	$	2		10	%
Interest expense		(7	)		0	%		(11	)		0	%		4		(36	%)
Other income (expense), net		-			0	%		(1	)		0	%		1		(100	%)
Total non-operating income (expense), net	$	16			0	%	$	9			0	%	$	7		78	%

Income tax expense	$	-			0	%	$	(4	)		0	%	$	4		100	%

	Nine Months Ended September 30,
	2012			% of Revenue			2011			% of Revenue			Dollar Change			% Change
Non-operating income (expense), net
Interest income	$	64			0	%	$	68			0	%	$	(4	)		(6	%)
Interest expense		(28	)		0	%		(64	)		0	%		36			(56	%)
Other income (expense), net		(4	)		0	%		325			1	%		(329	)		(101	%)
Total non-operating income (expense), net	$	32			0	%	$	329			1	%	$	(297	)		(90	%)

Income tax expense	$	-			0	%	$	(3	)		0	%	$	3			(100	%)

Interest Income and Expense

Interest expense, primarily consisting of interest paid on capital leases, decreased during the three and nine months ended September 30, 2012, as compared to the three and nine months ended September 30, 2011. This decrease was primarily due to a reduction in capital lease obligations.

Other Income (Expense), Net

In 2008, the Company established a settlement fund related to a class action lawsuit in which the Company was named as a defendant, Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc. (the “Fund”). In the second quarter of 2011, the Company determined that all settlements related to the Fund had been paid. The Fund was closed on June 30, 2011, and the Company recorded $0.3 million in non-operating income (expense), net related to the closure. This amount is included in other income (expense), net for the three and nine months ended September 30, 2011.

Income Tax Expense

Due to our utilizable net operating losses, our income tax expense in the U.S. consists of minimum state taxes. We do not anticipate any tax expense in Canada in 2012.

Liquidity and Capital Resources

The decrease in cash and cash equivalents is as follows for the nine months ended September 30, 2012, and 2011 (in thousands):

	Nine Months Ended September 30,
	2012			2011			Change
Net cash provided by (used in) operating activities	$	(5,220	)	$	151		$	(5,371	)
Net cash used in investing activities		(5,727	)		(5,526	)		(201	)
Net cash used in financing activities		(463	)		(798	)		335
Effect of exchange rate changes on cash and cash equivalents		(34	)		(5	)		(29	)
Decrease in cash and cash equivalents	$	(11,444	)	$	(6,178	)	$	(5,266	)

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Cash, cash equivalents and short-term investment balances were as follows as of September 30, 2012, and December 31, 2011 (in thousands):

	September 30,			December 31,
	2012			2011			Change
Cash and cash equivalents	$	6,506		$	17,950		$	(11,444	)
Short-term investments		11,118			6,809			4,309
Total	$	17,624		$	24,759		$	(7,135	)
% of total assets		76	%		82	%
Total assets	$	23,176		$	30,112

At September 30, 2012, we had $17.6 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 and U.S. corporate securities. We actively monitor the depository institutions that hold our cash and cash equivalents and the institutions of whose debt instruments we hold. Our investment policy, which is reviewed annually by our Board of Directors, primarily emphasizes safety of principal while secondarily on maximizing yield on those funds. We can provide no assurances that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial markets. These balances may exceed the Federal Deposit Insurance Corporation insurance limits. While we monitor the cash balances in our operating accounts and adjust the cash balances as appropriate, these cash balances could be impacted if the underlying financial institutions fail or could be subject to other adverse conditions in the financial markets. See Note 2 to the Unaudited Consolidated Financial Statements, “Cash, Cash Equivalents and Short-Term Investments,” which describes further the composition of our cash, cash equivalents and short-term investments.

Cash, cash equivalents and short-term investments decreased $7.2 million to $17.6 million at September 30, 2012, from $24.8 million at December 31, 2011, primarily due to operating losses, the use of capital to acquire equipment, principal payments on capital leases, and decreased accounts payable.

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, investment in software development, and financing obligations. 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. In addition, our liquidity could be negatively affected if we are in default under our credit facilities and are required to pay the lenders cash in an amount equal to the capital lease balance, or are required to identify restricted cash equal to the capital lease balance, plus an outstanding standby letter of credit. Also, if the banking system or the financial markets continue to remain volatile, our investment portfolio may be impacted and the values and liquidity of our investments could be adversely affected. In addition, continuing to respond to PEEK’s unsolicited tender offer may require LookSmart to incur significant additional costs and could have an adverse effect on the Company’s operations. 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, 2012, 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 first nine months of 2012 was $5.2 million and consisted of a net loss of $7.2 million, adjustments for non-cash items of $2.2 million and cash used by working capital and other activities of $0.3 million. Adjustments for non-cash items primarily consisted of $1.6 million of depreciation and amortization expense on property and equipment and internally developed software, $0.3 million bad debt expense and $0.2 million of share-based compensation expense. In addition, changes in working capital activities primarily consisted of a $0.5 million net increase in accounts payable and accrued liabilities, combined with an increase of $0.7 million in accounts receivable. The increase in accounts payable and accrued liabilities was primarily due to increased TAC and operating expenses. The increase in accounts receivable is primarily attributed to an increase in invoiced customer revenue.

Cash provided by operating activities in the nine months ended September 30, 2011, consisted of our net loss adjusted for certain non-cash items, including depreciation, amortization, and share-based compensation expense, as well as the effect of changes in working capital and other activities. Cash provided by operations in the first nine months of 2011 was $151 thousand and consisted of a net loss of $0.7 million, adjustments for non-cash items of $2.0 million and cash used by working capital and other activities of $1.2 million. Adjustments for non-cash items primarily consisted of $2.0 million of depreciation and amortization expense on property and equipment and internally developed software and $0.3 million of share-based compensation expense. In addition, changes in working capital activities primarily consisted of a $1.3 million decrease in accounts payable and accrued liabilities partially offset by a net decrease of $0.1 million in accounts receivable. The decrease in accounts payable and accrued liabilities was primarily due to reduced TAC and lower operating expenses. The decrease in accounts receivables is primarily attributed to the decrease in revenue and improvement in collections.

Investing Activities

Cash used in investing activities in the first nine months of 2012 of $5.7 million was primarily attributed to $4.3 million net purchase of investments. Capital expenditures in the first nine months of 2012 consisted of $0.4 million for equipment acquired during the period and an investment of $1.0 million in internally developed software related to our AdCenter platform technology.

Cash used in investing activities in the first nine months of 2011 of $5.5 million was primarily attributed to $4.9 million net purchase of investments. Capital expenditures in the first nine months of 2011 consisted of $0.4 million for equipment acquired during the period and an investment of $0.3 million in internally developed software related to our AdCenter platform technology.

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Financing Activities

Cash used in financing activities in the first nine months of 2012 of $0.5 million is primarily attributed to scheduled capital lease payments.

Cash used in financing activities in the first nine months of 2011 of $0.8 million is primarily attributed to scheduled capital lease payments.

Credit Arrangements

We have an outstanding standby letters of credit (“SBLC”) issued by City National Bank (“CNB”) of approximately $0.2 million at September 30, 2012, related to security of our corporate office lease.

We have 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. As of September 30, 2012, our outstanding balance was $0.2 million.

Our agreements with CNB, consisting of the SBLC and master equipment lease agreement, contain cross-default provisions whereby a default under one is deemed a default for the other, and are secured by a general lien on all assets of the Company. As of September 30, 2012, and December 31, 2011 we are in compliance with both agreements with CNB.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements as defined in Regulation S-K Item 303(a)(4), investments in special-purpose entities or undisclosed borrowings or debt. Additionally, we are not a party to any derivative contracts or synthetic leases.

Contractual Obligations and Commercial Commitments

In comparison with our Annual Report on Form 10-K for the year ended December 31, 2011, 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, 2012.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in rules promulgated under the Securities Exchange Act of 1934, as amended) for our Company. Based on their evaluation as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in this Quarterly Report on Form 10-Q is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and Form 10-Q, and (ii) is accumulated and communicated to the Company’s management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Controls

There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) during the quarter ended September 30, 2012, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Limitations on the Effectiveness of Controls

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a Company have been detected. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives, and the Chief Executive Officer and the Chief Financial Officer have concluded that these controls and procedures are effective at the “reasonable assurance” level.

Table of Contents

PART II

ITEM 1.

LEGAL PROCEEDINGS

None.

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, 2011.

Our securities may be delisted

The NASDAQ Stock Market (“NASDAQ”) 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. On June 1, 2012, we received from NASDAQ a deficiency notice letter indicating that for 30 consecutive business days the bid price of our common stock has closed below the minimum $1.00 per share requirement for continued inclusion on NASDAQ. In accordance with Marketplace Rule 5810(c)(3)(A), we have 180 calendar days, or until November 28, 2012, to regain compliance. If at any time before November 28, 2012 the bid price of our common stock closes at $1.00 per share or more for a minimum of ten consecutive business days, NASDAQ will provide written notification that we have achieved compliance. If we do not regain compliance by November 28, 2012, then we may apply to transfer our securities to The NASDAQ Capital Market and may obtain additional time in which to regain compliance with the minimum bid price rule. If NASDAQ concludes that we will not be able to cure the deficiency, or if we do not submit a transfer application, NASDAQ would provide written notification that our common stock will be delisted, after which we may appeal the delisting determination to a Hearings Panel. At our 2012 Annual Meeting of Stockholders, our stockholders rejected a reverse stock split proposal to address the minimum closing bid price deficiency; therefore, we may not be able to regain compliance with the minimum closing bid price rule before the required deadline.

In addition, we need to have at least 300 public holders to remain listed on the Nasdaq Capital Market and at least 400 public holders to remain listed on the Nasdaq Global Market. As a result of the unsolicited tender offer, the number of our record and beneficial holders may drop below the NASDAQ requirement. No assurance can be given that we will remain in compliance with other 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 Stockholder Rights Plan, provisions of Delaware corporate law and provisions of our charter and bylaws may discourage a takeover attempt, which could adversely affect the value of our Common Stock

Our board of directors has adopted a Stockholder Rights Plan, which could prevent or delay a takeover of Looksmart by causing substantial dilution to a potential acquirer that attempts to acquire beneficial ownership of more than 15% of our common stock on terms not approved by our board of directors. In addition, 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.

PEEK Investments unsolicited takeover attempt may continue to distract our management and employees, result in substantial legal and other advisory expenses, and create uncertainty that may adversely affect our business and results.

In July 2012, 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 our common stock for $1.00 per share. As extended, the tender offer is scheduled to expire on November 30, 2012. As more fully described in the Company’s Solicitation/Recommendation on Schedule 14D-9 filed with the SEC on August 2, 2012, as amended, in response to the offer, the Company’s Board of Directors unanimously recommended that the Company’s stockholders reject the offer and not tender their shares to PEEK for purchase. As of September 30, 2012, the Company has recorded approximately $0.6 million of expenses incurred in connection with the offer, consisting primarily of legal, advisory and other professional fees.

The review, consideration, and response to PEEK’s efforts to gain control of our Company require the expenditure of significant time and resources by us and may be a significant distraction for our management and employees. Acquisition efforts have also created uncertainty for our employees and this uncertainty may adversely affect our ability to retain key employees and to attract new employees. In addition, PEEK’s acquisition efforts have created and may continue to create uncertainty for current and potential partners, suppliers and customers. The impact of PEEK’s acquisition efforts due to these or other factors may undermine our business and have a material adverse effect on our results of operations, and may cause increased volatility and wide price fluctuations in our stock price.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Repurchase of Equity Securities by the Company

Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as a Part of Publicly Announced Plans or Programs (1)		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
July 1, 2012 - July 31, 2012		-	$	-		-	$	1,000,000
August 1, 2012 - August 31, 2012		10,800		0.87		-	$	990,604
September 1, 2012 - September 30, 2012		28,891		0.86		-	$	965,758
Total		39,691	$	0.86		-	$	965,758

(1)

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.

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.

Table of Contents

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

LOOKSMART, LTD.

Dated: November 14, 2012

By:	/s/ William O’Kelly
	William O’Kelly
	Senior Vice President Operations
	and Chief Financial Officer

Table of Contents

EXHIBIT INDEX

Exhibits

Number	Description of Document

3.1	Registrant’s Certificate of Incorporation (including Certificate of Designation of Series A Participating Preferred Stock) (Filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 23, 2012).

3.2	Bylaws (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on August 14, 2000).

4.1	Form of Specimen Stock Certificate (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on November 14, 2005).

4.2	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).

4.3	Form of Rights Certificate (Filed as Exhibit 4.2 to the Company’s Current Report on Form 8-K filed with the SEC on August 23, 2012).

10.86*	Sublease Agreement between the Company and Rocket Lawyer, Inc. for property located at 55 Second Street, San Francisco, California, dated June 30, 2012.

31.1*	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2*	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1*	Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS**	XBRL Instance Document

101.SCH**	XBRL Taxonomy Extension Schema

101.CAL**	XBRL Taxonomy Extension Calculation Linkbase

101.DEF**	XBRL Taxonomy Extension Definition Linkbase

101.LAB**	XBRL Taxonomy Extension Label Linkbase

101.PRE**	XBRL Taxonomy Extension Presentation Linkbase

(*)	Filed herewith

(**)

Pursuant to applicable securities laws and regulations, we are deemed to have complied with the reporting obligation relating to the submission of interactive data files in such exhibits and are not subject to liability under any anti-fraud provisions of the federal securities laws as long as we have made a good faith attempt to comply with the submission requirements and promptly amend the interactive data files after becoming aware that the interactive data files fail to comply with the submission requirements. In accordance with Rule 406T of Regulation S-T, the information in these exhibits is furnished and deemed not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.

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

Large accelerated filer	o	Accelerated filer	o

Non-accelerated filer	o	Smaller reporting company	x

	September 30, 2012			December 31, 2011
ASSETS	(Unaudited)
Current assets:
Cash and cash equivalents	$	6,506		$	17,950
Short-term investments		11,118			6,809
Total cash, cash equivalents and short-term investments		17,624			24,759
Trade accounts receivable, net		2,018			1,588
Prepaid expenses and other current assets		571			604
Total current assets		20,213			26,951
Property and equipment, net		1,179			1,941
Capitalized software and other assets, net		1,784			1,220
Total assets	$	23,176		$	30,112
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable	$	1,909		$	1,682
Accrued liabilities		1,207			895
Deferred revenue and customer deposits		1,125			1,143
Current portion of capital lease obligations		208			515
Total current liabilities		4,449			4,235
Capital lease and other obligations, net of current portion		150			296
Total liabilities		4,599			4,531
Stockholders' equity:
Convertible preferred stock, $0.001 par value; Authorized: 5,000 shares at September 30, 2012 and December 31, 2011; Issued and Outstanding: none at September 30, 2012 and December 31, 2011		-			-
Common stock, $0.001 par value; Authorized: 80,000 shares; Issued and Outstanding: 17,306 shares and 17,288 shares at September 30, 2012 and December 31, 2011, respectively		17			17
Additional paid-in capital		262,402			262,201
Accumulated other comprehensive loss		(32	)		(24	)
Accumulated deficit		(243,776	)		(236,613	)
Treasury stock at cost: 40 shares at September 30, 2012		(34	)		-
Total stockholders' equity		18,577			25,581
Total liabilities and stockholders' equity	$	23,176		$	30,112

ITEM 1	FINANCIAL STATEMENTS	3

	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	19

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	26

ITEM 4.	CONTROLS AND PROCEDURES	26

PART II. OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS	27

ITEM 1A.	RISK FACTORS	27

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	27

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	27

ITEM 4.	MINE SAFETY DISCLOSURES	27

ITEM 5.	OTHER INFORMATION	27

ITEM 6.	EXHIBITS	27

SIGNATURE		28

EXHIBIT INDEX		29

	September 30, 2012			December 31, 2011
Company 1		33	%		**
Company 2		12	%		20	%
Company 3		**			12	%

Computer equipment	3 to 4 years
Furniture and fixtures	5 to 7 years
Software	2 to 3 years