Form 10-Q

10-Q 1 d10q.htm FORM 10-Q Form 10-Q

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, 2008

¨	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.)

625 Second Street

San Francisco, California 94107

(415) 348-7000

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $0.001 per share

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer, as defined in Rule 12b-2 of the Exchange Act.


Large accelerated filer ¨		Accelerated filer x

Non-accelerated filer ¨		Smaller reporting company x

Indicate by check mark whether the registrant is a shell company, as defined in Rule 12b-2 of the Exchange Act. Yes ¨ No x

As of July 31, 2008, there were 17,035,948 shares of the registrant’s common stock outstanding, par value $0.001 per share.

TABLE OF CONTENTS


PART I		3

ITEM 1.	FINANCIAL INFORMATION	3

	CONDENSED CONSOLIDATED BALANCE SHEETS	3

	CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS	4

	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS	5

	NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	6

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	19

ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	32

ITEM 4.	CONTROLS AND PROCEDURES	32

PART II		33

ITEM 1.	LEGAL PROCEEDINGS	33

ITEM 1A.	RISK FACTORS	34

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	42

ITEM 4.	SUBMISSION OF MATTERS OF A VOTE OF SECURITY HOLDERS.	42

ITEM 6.	EXHIBITS	43

SIGNATURE		44

EXHIBIT INDEX		45

PART I

ITEM 1.

FINANCIAL INFORMATION

LOOKSMART, LTD.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)


	June 30, 2008			December 31, 2007
ASSETS
Current assets:
Cash and cash equivalents	$	13,321		$	35,743
Short-term investments		21,101			20,464

Total cash, cash equivalents and short-term investments		34,422			56,207
Trade accounts receivable, net of allowance for doubtful accounts of $290 and $429 at June 30, 2008 and December 31, 2007, respectively, and allowance for returns of $224 and $37 at June 30, 2008 and December 31, 2007, respectively		6,125			5,183
Prepaid expenses		709			638
Other current assets		932			1,628

Total current assets		42,188			63,656
Property and equipment, net		2,934			3,401
Capitalized software and other assets, net		2,175			2,693
Intangible assets, net		319			247
Goodwill		9,810			10,296
Assets held for sale		1,010			—

Total assets	$	58,436		$	80,293

LIABILITIES & STOCKHOLDERS’ EQUITY
Current liabilities:
Trade accounts payable	$	4,327		$	3,407
Accrued expenses and other accrued liabilities		5,555			8,437
Deferred revenue and customer deposits		1,800			1,596
Current portion of long term liabilities		1,672			1,621

Total current liabilities		13,354			15,061
Lease restructuring and other long-term liabilities, net of current portion		1,756			2,277

Total liabilities		15,110			17,338
Commitment and contingencies (NOTE 7)
Stockholders’ equity:
Convertible preferred stock, $0.001 par value: 5,000 at June 30, 2008 and December 31, 2007; issued and outstanding: none at June 30, 2008 and December 31, 2007, respectively		—			—
Common stock, $0.001 par value; Authorized: 200,000 at June 30, 2008 and December 31, 2007; issued and outstanding 17,035 and 22,925 at June 30, 2008 and December 31, 2007, respectively		17			23
Additional paid-in capital		258,021			276,964
Other equity		(4	)		12
Accumulated deficit		(214,708	)		(214,044	)

Total stockholders’ equity		43,326			62,955

Total liabilities and stockholders’ equity	$	58,436		$	80,293

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

The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

LOOKSMART, LTD.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Revenue	$	17,092		$	13,493		$	34,636		$	25,416
Cost of revenue		10,318			7,330			20,476			14,073

Gross profit		6,774			6,163			14,160			11,343
Operating expenses:
Sales and marketing		1,994			2,223			4,210			4,351
Product development		2,833			2,943			5,738			6,044
General and administrative		2,362			2,918			5,234			5,914
Restructuring costs		(135	)		—			(135	)		—

Total operating expenses		7,054			8,084			15,047			16,309

Loss from operations		(280	)		(1,921	)		(887	)		(4,966	)
Non-operating income, net		247			518			680			1,033

Loss from continuing operations before income taxes		(33	)		(1,403	)		(207	)		(3,933	)
Income tax expense		(7	)		—			(14	)		(6	)

Loss from continuing operations		(40	)		(1,403	)		(221	)		(3,939	)
Loss from discontinued operations, net of tax		(136	)		(665	)		(443	)		(1,554	)

Net loss	$	(176	)	$	(2,068	)	$	(664	)	$	(5,493	)

Net loss per share - Basic and Diluted
Loss from continuing operations	$	(0.00	)	$	(0.06	)	$	(0.01	)	$	(0.17	)
Loss from discontinued operations, net of tax		(0.01	)		(0.03	)		(0.03	)		(0.07	)

Net loss per share	$	(0.01	)	$	(0.09	)	$	(0.04	)	$	(0.24	)

Weighted average shares outstanding used in per share calculation		16,998			22,900			18,773			22,893

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

LOOKSMART, LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)


	Six months ended June 30,
	2008			2007
Cash flows from operating activities:
Net loss	$	(664	)	$	(5,493	)
Adjustment to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		1,693			2,613
Restructuring benefit		(135	)		—
Share-based compensation		1,583			1,105
(Gain) loss from sale of assets and other non-cash charges		(98	)		229
Changes in operating assets and liabilities:
Trade accounts receivable, net		(942	)		(972	)
Prepaid expenses and other current assets		(55	)		(705	)
Trade accounts payable		920			1,166
Accrued expenses and other current liabilities		(2,775	)		957
Other long-term liabilities		(642	)		(427	)
Deferred revenue and customer deposits		204			(361	)

Net cash used in operating activities		(911	)		(1,888	)

Cash flows from investing activities:
Purchase of short-term investments		(24,507	)		(16,646	)
Proceeds from sale and maturities of short-term investments		23,889			10,347
Payments for property, equipment and capitalized software development		(966	)		(1,332	)
Purchase of intangible assets		(280	)		—
Proceeds from sale of certain consumer assets		1,025			—
Proceeds from contingent purchase consideration of certain consumer assets		174			—

Net cash used in investing activities		(665	)		(7,631	)

Cash flows from financing activities:
Principal payments under notes and capital lease obligations		(246	)		(49	)
Proceeds from sale and leaseback of equipment		—			211
Proceeds from issuance of common stock		176			159
Payments for repurchase of common stock		(20,776	)		—

Net cash provided by (used in) financing activities		(20,846	)		321

Decrease in cash and cash equivalents		(22,422	)		(9,198	)
Cash and cash equivalents, beginning of period		35,743			32,901

Cash and cash equivalents, end of period	$	13,321		$	23,703

Supplemental disclosure of noncash activities
Assets acquired through capital lease obligations	$	553		$	—
Reclass of property and equipment, capitalized software, and intangible assets related to certain consumer assets to assets held for sale, net	$	1,010		$	—
Increase in prepaid expenses other current assets associated with sale of certain consumer assets	$	220		$	—

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

LOOKSMART, LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

Nature of Business and Principles of Consolidation

LookSmart is an online search advertising and technology solutions company that provides relevant solutions for advertisers and publishers. Historically, LookSmart has provided three service offerings, or “products”: 1) online advertiser networks, 2) publisher solutions, and 3) consumer products.

Advertiser networks: LookSmart offers advertisers targeted, pay-per-click (PPC) search, and contextual search advertising via a monitored search advertising distribution network. The Company’s extensive ad distribution network includes publishers and search partners. The Company’s application programming interface (API) allows search advertisers and their advertising agencies to connect any type of marketing or reporting software with minimal effort, for easier access, management, and optimization of ad campaigns.

Publisher solutions: LookSmart offers publishers a customizable set of private-label open advertiser network solutions. LookSmart’s publisher solutions consist of a hosted auction-based ad serving platform with an ad backfill capability that allows search engines, networks, media companies, social networking sites, retail sites, directories, ISPs and portals to manage their advertiser relationships, distribution channels and accounts. The unique capability to interconnect multiple sources of advertisers, including multiple installations of the LookSmart AdCenter for Publishers platform, creates an open marketplace environment through which publishers can mutually share advertisers and advertisers can gain greater distribution through an extended network of linked publishers.

Consumer products: In 2007, the Company’s management made the decision to exit certain consumer products activities and to sell or otherwise dispose of the various related websites and assets associated with those activities. During 2007 the Company sold FindArticles, the assets relating to Grub, the websites associated with Zeal and completed the shutdown of the Wisenut website and search functionality. In the first quarter of 2008 the Company’s management made the decision to exit the remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. Additionally, during the first quarter of 2008 Furl assets have been accounted for under the guidance of SFAS 144 Accounting for the Impairment or Disposal of Long-Lived assets (“SFAS 144”) as “assets held for sale,” and these, together with, the various related websites and assets associated with the consumer products activities previously disposed of, met the discontinued operations criteria in accordance with the provisions of SFAS No. 144. The results of operations of consumer product activities, including related gains (losses), have been classified as discontinued operations for all periods presented in the accompanying Unaudited Condensed Consolidated Statements of Operations. See Footnotes 2, 3 and 4 for further details. At June 30, 2008, the Company continues to own the Wisenut search engine technology and its intellectual property rights in such technology and other assets, and owns and operates Furl.

LookSmart was organized in 1996, as an Internal Revenue Code 26(A)(1) subchapter (C) corporation, and is incorporated in the State of Delaware.

The Unaudited Condensed Consolidated Financial Statements as of June 30, 2008 and for the three and six months ended June 30, 2008 and 2007 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 Condensed Consolidated Financial Statements as of June 30, 2008 and for the three and six months ended June 30, 2008 and 2007 reflect all adjustments that are normal and recurring in nature and, in the opinion of management, are necessary for a fair representation of the results of operations for the periods shown. These Unaudited Condensed 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 fiscal year ended December 31, 2007. The Unaudited Condensed Consolidated Balance Sheet as of December 31, 2007 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The results of operations for the interim periods ended June 30, 2008 are not necessarily indicative of results to be expected for the full year.

Use of Estimates and Assumptions

The Unaudited Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States. 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, 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. All adjustments are of a normal or recurring nature.

Reclassifications

Certain amounts in the financial statements for 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.

Fair Value of Financial Instruments

The Company’s financial instruments, including cash and cash equivalents, trade accounts receivable, trade accounts payable, and other accrued liabilities are carried at cost, which approximates fair value due to the relatively short maturity of those instruments. Short-term investments are carried at fair value. Based upon borrowing rates with similar terms currently available to the Company, the carrying value of notes payable approximates fair value.

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, Fair Value Measures (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS 157 became effective for the Company on January 1, 2008.

In February 2008, the FASB issued FASB Staff Position FAS No. 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13” (“FSP FAS 157-1”). FSP FAS 157-1 provides a scope exception from SFAS 157 for the evaluation criteria on lease classification and capital lease measurement under SFAS No. 13, “Accounting for Leases” and other related accounting pronouncements. Accordingly, the Company did not apply the provisions of SFAS 157 in determining the classification of and accounting for leases.

In February 2008, the FASB issued FSP FAS No. 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”) which delays the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for certain nonfinancial assets and nonfinancial liabilities. FSP FAS 157-2 will become effective for the Company on January 1, 2009. The Company is in the process of evaluating the impact of applying FSP FAS 157-2 to nonfinancial assets and liabilities measured on a nonrecurring basis. Examples of items to which the deferral would apply include, but are not limited to:

•

reporting units measured at fair value in the first step of a goodwill impairment test as described in Statement of Financial Standards No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), and nonfinancial assets and nonfinancial liabilities measured at fair value in the SFAS 142 goodwill impairment test, if applicable;

•

indefinite-lived intangible assets measured at fair value for impairment assessment under SFAS 142, and nonfinancial long-lived assets (asset groups) measured at fair value for an impairment assessment under SFAS 144; and

•

nonfinancial liabilities for exit or disposal activities initially measured at fair value under Statement of Financial Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”).

As a result of the issuance of FSP FAS 157-2, the Company did not apply the provisions of SFAS 157 to the nonfinancial assets and nonfinancial liabilities within the scope of FSP FAS 157-2.

SFAS 157 requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three levels:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

The fair values of the Company’s cash equivalents and short term investments are based on quoted prices in active markets for identical assets. The following table summarized the carrying amounts and fair values of certain assets at June 30, 2008 (in thousands):


	Balance at June 30, 2008		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other observable Inputs (Level 2)		Significant unobservable Inputs (Level 3)
Cash equivalents:
Money market funds	$	6,057	$	6,057	$	—	$	—
Commercial paper		3,388		—		3,388		—

		9,445		6,057		3,388		—
Short-term investments:
Corporate bonds		6,631		—		6,631		—
Variable-rate notes		2,000		—		2,000		—
Commercial paper		4,575		—		4,575		—
U.S. government debt securities		991		—		991		—
Certificates of deposit		6,904		—		6,904		—

Total assets measured at fair value	$	30,546	$	6,057	$	24,489	$	—

In February 2007, the FASB issued SFAS No. 159 (“SFAS 159”), The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 . SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value, with changes in fair value recognized in earnings each reporting period. The election, called the fair value option, will enable entities to achieve an offset accounting effect for changes in fair value of certain related assets and liabilities without having to apply complex hedge accounting provisions. SFAS 159 is effective as of the beginning of the Company’s 2008 fiscal year. The Company has evaluated the provisions of SFAS 159 and did not elect the fair value option at this time.

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, short-term investments, and accounts receivable. As of June 30, 2008 and December 31, 2007, we placed our investments primarily through one financial institution, City National Bank (“CNB”), and mitigated the concentration of credit risk by placing percentage limits on the maximum portion of the investment portfolio which may be invested in any one investment instrument. The fair value of these investments is subject to fluctuation based on market prices.

Credit Risk, Customer and Vendor Evaluation

Accounts receivable are typically unsecured and are derived from sales to customers. The Company performs ongoing credit evaluations of its customers and maintains allowances for estimated credit losses. The Company applies judgment as to its ability to collect outstanding receivables based primarily on management’s evaluation of the customer’s financial condition and past collection history and records a specific allowance. In addition, the Company records an allowance based on the length of time the receivables are past due. Historically, such losses have been within management’s expectations.

As of June 30, 2008, one customer accounted for 10% or more of gross accounts receivable, representing 28% of gross accounts receivable at June 30, 2008. As of December 31, 2007, two customers accounted for 21% and 22% of gross accounts receivable, respectively. There were no other customers who accounted for 10% or more of gross accounts receivable as of June 30, 2008 and December 31, 2007. As of June 30, 2008 there was no deterioration in the Company’s accounts receivables.

The Company derives its revenue primarily from its relationships with significant distribution network partners. For the three months ended June 30, 2008, three vendors each accounted for over 10% of total traffic acquisition costs (“TAC”). These three vendors accounted for a total of 34% of the total TAC for the three months ended June 30, 2008. For the six months ended June 30, 2008, two vendors each accounted for over 10% of total traffic acquisition costs. These two vendors accounted for a total of 22% of the total TAC for the six months ended June 30, 2008. For the three months ended June 30, 2007, three vendors accounted for more than 10% of the total TAC. For the six months ended June 30, 2007, only one of these three vendors accounted for more than 10% of the total TAC. These three vendors accounted for a total of 42% and 38% of the total traffic acquisition costs for the three and six months ended June 30, 2007, respectively.

Revenue Concentrations

The United States was the only country which accounted for 10% or more of net or gross revenue for the three and six months ended June 30, 2008. The United States accounted for 82% and 83% of gross revenue for the three and six months ended June 30, 2008.

LookSmart derives its revenue from two service offerings, or “products”: Advertising Networks and Publisher Solutions. For the three and six months ended June 30, 2008, Advertising Networks represented 92% and 91% of total net revenues, respectively. The remaining 8% and 9% of total net revenues was derived from Publishing Solutions. For both the three and six months ended June 30, 2007, Advertising Networks represented 90% of total net revenues, with the remaining 10% of total net revenues derived from Publishing Solutions

Two customers represented approximately 12% and 16% of total net revenues for the three months ended June 30, 2008, and 17% and 13% of total net revenues for the six months ended June 30, 2008. There were no other customers who accounted for 10% or more of total net revenues in the three and six months ended June 30, 2008. For the three and six months ended June 30, 2007 two customers represented approximately 29% and 20% of total net revenues, respectively. There were no other customers who accounted for 10% or more of total net revenues in the three and six months ended June 30, 2007.

Share-Based Compensation

Share-based compensation expense recognized under SFAS 123R for the three and six months ended June 30, 2008 was approximately $0.6 million and $1.6 million, respectively, and approximately $0.6 million and $1.2 million for the three and six months ended June 30, 2007, respectively, which was related to stock options and employee stock purchases. SFAS 123R requires companies to estimate the fair value of share-based payment awards on the grant date using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense in the Company’s Unaudited Condensed Consolidated Statement of Operations over the requisite service periods.

SFAS 123R requires forfeitures to be 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 beginning of each fiscal year, based on historical rates, and reviewed on a periodic basis. Share-based compensation expense recognized in the Company’s Unaudited Condensed Consolidated Statement of Operations for the three and six months ended June 30, 2008 and 2007 includes (i) compensation expense for share-based payment awards granted prior to, but not yet fully vested as of December 31, 2005, based on the grant-date fair value estimated in accordance with the pro forma provisions of SFAS 123 and (ii) compensation expense for the share-based payment awards granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.

Under the provisions of SFAS 123R the Company continues its use of the Black-Scholes method of valuation for share-based awards granted beginning in fiscal 2006, which was previously used for the Company’s pro forma information required under SFAS 123. On November 10, 2005, the FASB issued FASB Staff Position No. SFAS 123R-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards (“SFAS 123R-3”). The alternative transition method includes simplified methods 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 Unaudited Condensed Consolidated Statements of Cash Flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS 123R. The Company has elected to adopt the alternative transition method provided in this FASB Staff Position for calculating the tax effects of share-based compensation pursuant to SFAS 123R-3.

Net Income (Loss) per Common Share

SFAS No. 128, Earnings per Share (“SFAS 128”), establishes standards for computing and presenting net income (loss) per share. Basic net income (loss) per share is calculated using the weighted average shares of common stock outstanding. Diluted net income (loss) 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 and warrants.

Recently Issued Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141R, Business Combinations (“SFAS 141R”), which revised SFAS No. 141 Business Combinations (“SFAS 141”). SFAS 141R requires the acquiring entity in a business combination to recognize all the assets acquired and liabilities assumed in the transaction and any noncontrolling interest in the acquiree; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; requires the acquirer to disclose all information needed to evaluate and understand the nature and financial effect of the business combination; and requires the acquirer to expense acquisition-related costs in the periods in which the costs are incurred and the services are received except for the costs to issue debt or equity securities. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008, and is effective for the Company at the beginning of fiscal year 2009. Early adoption is prohibited. We are currently reviewing the provisions of SFAS 141R to determine the impact on our Unaudited Condensed Consolidated Financial Statements.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008, and is effective for the Company at the beginning of fiscal year 2009. Earlier adoption is prohibited. We are currently reviewing the provisions of SFAS 160 to determine the impact on our Unaudited Condensed Consolidated Financial Statements.

2. Discontinued Operations

In 2007, the Company’s management made the decision to exit certain foreign markets, and has reclassified its financial statements to reflect these foreign operations as discontinued.

During 2007 the Company sold FindArticles, the assets relating to Grub, and the websites associated with Zeal and completed the shutdown of the Wisenut website and search functionality.

In the first quarter of 2008, the Company’s management made the decision to exit the remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. Additionally, during the first quarter of 2008, Furl assets have been accounted for under the guidance of SFAS 144 Accounting for the Impairment or Disposal of Long-Lived assets (“SFAS 144”) as “assets held for sale,” and these, together with, the various related websites and assets associated with the consumer products activities previously disposed of, and the foreign operations previously disposed of, met the discontinued operations criteria in accordance with the provisions of SFAS No. 144. The results of operations of assets to be disposed of, and of previously disposed assets, including related gains (losses) have been classified as discontinued operations for all periods presented in the accompanying Unaudited Condensed Consolidated Statements of Operations.

In the second quarter the Company sold the intellectual property rights to the domain name “Wisenut” and other related domain names for proceeds of approximately $0.2 million and realized approximately $0.2 million as a gain on sale of assets that is included in discontinued operations. The proceeds from the sale were collected in July 2008.

At June 30, 2008, the Company continues to own the Wisenut search engine technology and its intellectual property rights in such technology and other assets and owns and operates Furl.

During the three months ended June 30, 2008 the Company recorded an additional gain in foreign general and administrative expense of approximately $6 thousand relating to the finalization of the liquidation of various foreign operations in the first quarter of 2007. For the six months ended June 30, 2008, expenses related to the liquidation of the Company’s various foreign operations was approximately $29 thousand. For both the three and six months ended June 30, 2007, expenses related to the liquidation of the Company’s various foreign operations was approximately $0.1 million. The Company expects to finalize the dissolution of these entities during 2008.

The following table reflects revenue, gross profit, operating expenses, pre-tax income (loss) from discontinued operations and gain (loss) on sale of discontinued operations for the quarters ended June 30, 2008 and June 30, 2007 (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Revenue	$	26		$	1,131		$	52		$	2,434

Gross profit	$	80		$	280		$	31		$	672
Product development expenses		189			946			520			2,018
General and administrative expenses		(5	)		73			35			85
Impairment charges		381			—			381			—
Non-operating income, net		9			—			9			—

Pretax net loss (excluding gain on disposal)		(476	)		(739	)		(896	)		(1,431	)

Gain (loss) on disposal		340			74			453			(123	)

Net loss from discontinued operations, net of tax	$	(136	)	$	(665	)	$	(443	)	$	(1,554	)

At June 30, 2008, certain assets relating to Furl have been accounted for under the guidance of SFAS 144 as “assets held for sale,” and have been classified as such on the Company’s Unaudited Condensed Consolidated Balance Sheet (in thousands):


	June 30, 2008
Property and equipment, net	$	70
Capitalized software, net		739
Goodwill		104
Intangibles, net		97

Total assets held for sale	$	1,010

Assets held for sale under the guidance of SFAS 144 are subject to periodic review. During the three months ended June 30, 2008, it was estimated by management that a goodwill impairment of approximately $0.4 million existed pursuant to an interim goodwill impairment assessment as described in Note 5. The estimate was based on recent precedent transactions in the social networking technology industry, adjusted for the current market for this type of asset and the status of the sales process. Any adjustment to the estimated impairment based on more accurate measurement of the impairment shall be recognized in subsequent reporting periods.

3. Other Current Assets

Other current assets consisted of the following (in thousands):


	June 30, 2008		December 31, 2007
Escrow agreement assets	$	—	$	1,025
Other current assets		932		603

Total	$	932	$	1,628

Escrow agreement assets relate to monies held in escrow in relation to the sale of certain assets associated with the consumer products activities, which were collected in May 2008.

4. Property and Equipment

Property and equipment consisted of the following (in thousands):


	June 30, 2008			December 31, 2007
Computer equipment	$	14,991		$	15,187
Furniture and fixtures		1,152			1,126
Software		3,771			3,771
Leasehold improvements		2,901			2,736

Total		22,815			22,820
Less accumulated depreciation and amortization		(19,881	)		(19,419	)

Property and equipment, net	$	2,934		$	3,401

Depreciation expense on property and equipment for the three and six months ended June 30, 2008, including property and equipment under capital lease, was approximately $0.6 million and $1.2 million, respectively. Depreciation expense on property and equipment for the three and six months ended June 30, 2007 was approximately $0.6 million and $1.3 million, respectively. Equipment under capital lease amounted to approximately $1.6 million as of June 30, 2008 and approximately $1.1 million as of December 31, 2007. Depreciation expense on equipment under capital lease was approximately $0.1 million and $0.2 million for the three and six months ended June 30, 2008 and was not material for the three and six months ended June 30, 2007. Additionally, accumulated depreciation on equipment under capital lease was approximately $0.3 million as of June 30, 2008 and was not material for the three and six months ended June 30, 2007.

At June 30, 2008 certain property and equipment and capitalized software relating to Furl have been accounted for under the guidance of SFAS 144 as “assets held for sale,” and have been classified as such on the Company’s Unaudited Condensed Consolidated Balance Sheet (in thousands):


	June 30, 2008
Computer equipment	$	387
Accumulated depreciation		(317	)

Property and equipment, net	$	70

Capitalized software	$	1,025
Accumulated depreciation		(286	)

Capitalized software, net	$	739

5. Goodwill and Intangible Assets

The Company’s intangible assets consist primarily of purchased technology and have estimated useful lives of two to seven years. Goodwill and intangible assets are as follows (in thousands):


	June 30, 2008			December 31, 2007
Goodwill	$	9,810		$	10,296

Intangible assets:
Purchased technology	$	358		$	964
Less accumulated amortization		(39	)		(885	)

Net purchase technology		319			79

Trade names		—			1,062
Less accumulated amortization		—			(894	)

Net trade names		—			168

Other intangibles		—			930
Less accumulated amortization		—			(930	)

Net other intangibles		—			—

Intangible assets, net	$	319		$	247

Intangible asset amortization expense was approximately $13 thousand and $111 thousand for the three and six months ended June 30, 2008, and approximately $0.4 million and $0.9 million for the three and six months ended June 30, 2007, respectively, and was recorded primarily in product development expense.

As a result of classifying revenue and expenses generated by various related websites and assets associated with the consumer products activities as discontinued operations, amortization expense of intangibles related to those consumer assets has been reclassified to discontinued operations for the 2008 and 2007, respectively.

For the purpose of assessing goodwill impairment, the Company regularly reviews the impact of any changes to its business. In the first quarter of 2008, the Company classified Furl assets as “assets held for sale”. Approximately $0.5 million of goodwill was initially assigned to the Furl assets based on the estimated relative fair value of the assets and was classified as assets held for sale as of June 30, 2008. During the three months ended June 30, 2008, management estimated that the goodwill assigned to Furl was impaired based on a preliminary analysis of goodwill impairment performed due to the existence of indicators of impairment. Such impairment analysis has not been finalized due to additional time required to perform a complete analysis. Any significant adjustments to the initial approximately $0.4 million impairment estimate resulting from finalizing the impairment analysis will be reflected in subsequent periods.

At June 30, 2008 certain net intangible assets relating to Furl have been accounted for under the guidance of SFAS 144 as “assets held for sale,” and have been classified as such on the Company’s Unaudited Condensed Consolidated Balance Sheet (in thousands):


	June 30, 2008
Goodwill	$	104

Purchased technology	$	886
Trade name		1,062
Other intangibles		930
Accumulated amortization		(2,781	)

Intangible assets, net	$	97

6. Accrued Expenses and Other Accrued Liabilities

Accrued expenses and other accrued liabilities consisted of the following (in thousands):


	June 30, 2008		December 31, 2007
Accrued compensation and related expenses	$	989	$	2,015
Accrued distribution and partner costs		3,242		3,541
Accrued professional services		1,007		1,921
Customer refunds		25		55
Accrued equipment purchases		62		166
City business and personal property tax payable		—		41
Income taxes payable		33		244
Other		197		454

Total accrued expenses and other accrued liabilities	$	5,555	$	8,437

7. Lease Restructuring and Other Long-Term Liabilities

Lease restructuring and other long-term liabilities consist of the following (in thousands):


	June 30, 2008			December 31, 2007
Total lease restructuring liabilities	$	2,081		$	2,889
Capital lease obligation		1,347			1,009

Total other liabilities		3,428			3,898
Less: current portion		(1,672	)		(1,621	)

Lease restructuring and other long term liabilities, net of current portion	$	1,756		$	2,277

Total lease restructuring liabilities consist of the lease restructuring liability, notes payable and sublease deposits.

On April 6, 2007, the Company entered into a master equipment lease agreement with CNB for an amount of up to $5.0 million for the purchase of technical equipment. This lease line of credit expired on March 30, 2008 and was available for equipment leases with rental terms from 36 to 48 months. Interest on the capital lease was calculated using an interest rate of 7.38% per annum.

On April 1, 2008 the Company renewed its master equipment lease agreement with CNB for an amount of up to $3.5 million for the purchase of technical equipment. The renewed lease line of credit expires on December 30, 2008. Interest on the capital lease is calculated using an interest rate of 6.40% per annum.

Lease Restructuring

During 2003, the Company vacated portions of its leased headquarter office facilities, and incurred lease restructuring costs related to closing these facilities.

As of June 30, 2008 and December 31, 2007, the lease restructuring liability was approximately $2.1 million and $2.9 million, respectively. Of this amount, approximately $1.2 million was included in the current portion of other long-term liabilities as of June 30, 2008 and approximately $1.3 million was included in the current portion of other long-term liabilities as of December 31, 2007.

In the second quarter of 2008 we subleased approximately 6,500 square feet for which the Company previously took a restructuring charge in 2004. The additional sublease resulted in a reduction of approximately $0.1 million in the lease restructuring liability with the offset being a lease restructuring credit. The Company does not currently expect to incur significant further restructuring charges or receive additional benefits related to closing redundant leased facilities in 2008 as it has sublet most of its unused space.

The following table sets forth lease restructuring activity during the period ended June 30, 2008 (in thousands):


	Lease Restructuring Costs
Balance at December 31, 2007	$	2,889
Amounts paid and charged against the liability		(351	)

Balance at March 31, 2008		2,538
Amounts paid and charged against the liability		(322	)
Lease restructuring credit		(135	)

Balance as of June 30, 2008	$	2,081

8. Commitments and Contingencies

Capital and Operating Leases

The Company leases office space under a non-cancellable operating lease that expires in 2009, certain of which space is sublet under cancellable and non-cancellable subleases. In addition, beginning in 2007, the Company has acquired equipment under a master lease agreement (see Footnote 7).

As of June 30, 2008, future minimum payments under all capital and operating leases and minimum sublease rental income are as follows (in thousands):


	Capital Leases		Operating Leases		Minimum Sublease Rental Income
Six months ended December 31, 2008	$	268	$	2,378	$	1,376
Fiscal years ending December 31:
2009		537		4,412		2,447
2010		501		—		—
2011		184		—		—

Total	$	1,490	$	6,790	$	3,823

The Company has outstanding standby letters of credit (“SBLC”) related to security of its building lease and security for payroll processing services of approximately $1.1 million at June 30, 2008. The SBLC contains two financial covenants. As of June 30, 2008, the Company was in compliance with both financial covenants.

Guarantees and Indemnities

During its normal course of business, the Company has made certain guarantees, indemnities and commitments under which it may be required to make payments in relation to certain transactions. These indemnities include intellectual property and other indemnities to the Company’s customers and distribution network partners in connection with the sales of its products, and indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease. 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 future results of operations, cash flows or financial position in a future period. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense costs, diversion of management resources and other factors.

Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc

On March 14, 2005 the Company was served with the second amended complaint in a class action lawsuit in the Circuit Court of Miller County, Arkansas. The complaint names eleven search engines and web publishers as defendants, including the Company, and alleges breach of contract, restitution/unjust enrichment/money had and received, and civil conspiracy claims in connection with contracts allegedly entered into with plaintiffs for Internet pay-per-click advertising. The named plaintiffs on the second amended complaint are Lane’s Gifts and Collectibles, L.L.C., U.S. Citizens for Fair Credit Card Terms, Inc., Savings 4 Merchants, Inc., and Max Caulfield d/b/a Caulfield Investigations.

On March 30, 2005 the case was removed to United States District Court for the Western District of Arkansas. On April 4, 2005 plaintiffs U.S. Citizens for Fair Credit Card Terms, Inc. and Savings 4 Merchants, Inc. filed a motion of voluntary dismissal without prejudice. The motion was granted on April 7, 2005. Plaintiffs Lane’s Gifts and Collectibles, L.L.C. and Max Caulfield d/b/a Caulfield Investigations filed a motion to remand the case to state court on April 13, 2005, which was granted in June 2005. In July 2005, defendants, including the Company, petitioned the Eighth Circuit Court of Appeals for an appeal of the remand order, and moved to stay the proceedings while the appeal is pending. The petition was denied on September 8, 2005 and the case was remanded to the Circuit Court of Miller County, Arkansas. The Company was served with discovery requests on October 7, 2005. The Company has filed and/or joined motions to dismiss on the basis of failure to state a claim upon which relief can be granted, lack of personal jurisdiction, and improper venue. Pursuant to the court’s initial scheduling order, plaintiffs had until January 27, 2006 to respond to the motions to dismiss for lack of personal jurisdiction and improper venue; and until June 9, 2006 to respond to the motion to dismiss on the basis of failure to state a claim upon which relief can be granted. However the court entered an order staying all proceedings for a period of 60 days on January 9, 2006. On March 8, 2006, the Court entered an order extending the stay until June 30, 2006. On April 1, 2006, the Court further extended the stay until April 20, 2006. On April 20, 2006 the Court preliminarily approved a class settlement among plaintiffs, defendant Google, Inc., and certain defendants who display Google advertisements on their networks (the “Google Settlement”). The Google Settlement purports to release Google of all claims and also purports to release certain defendants, including the Company, for any claims associated with the display of Google advertisements on their networks. On July 24 and 25, 2006, the Court had a final settlement hearing on the Google Settlement, and on July 26, 2006, the Court approved the settlement. On April 21, 2006, the Court ordered the remaining defendants, including the Company, to mediation and further stayed the proceedings to June 21, 2006. The Court further extended the stay as to LookSmart until August 16, 2006. The parties thereafter stipulated that the stay would remain in effect while the parties continue to comply with the Court’s order regarding mediation. On January 10, 2007, the Court further extended the stay until May 1, 2007. On or about November 20, 2007, the Plaintiffs and the Company entered into a Stipulation and Settlement Agreement (the “Settlement Agreement”) to settle the matter in its entirety. On or about November 29, 2007, the Court preliminarily approved the Settlement Agreement and on February 29, 2008 the court entered an order to approve as final the Settlement Agreement. Pursuant to the Settlement Agreement, the Company has agreed to establish a Settlement Fund in the amount of up to approximately $2.5 million to be allocated as follows: (a) the Class Member Fund which should not exceed approximately $2.0 million in advertising credits, (b) the Fees Award to Class Counsel, which shall not exceed the amount of approximately $0.6 million; and (c) the Incentive Award (as hereinafter defined) to the three Class Representatives, which shall not exceed the collective amount of approximately $15 thousand. In the event that the total of the credit claims paid is less than approximately $0.8 million, the difference between the total amount of the credit claims paid and approximately $0.8 million will be paid to charities in the form of advertising credits. Should the total of the credit claims paid to the Settlement Class Members as a group plus any amounts allocated to charities be more than approximately $0.8 million but less than approximately $2.5 million, then the amount if any shall be retained by the Company. Settlement payments from the Class Member Fund will be paid out in advertising credits to members of the Class who file timely claims to participate in the settlement. On December 28, 2007, the Company provided the notices to class members required by the Settlement Agreement who had until February 11, 2008 to file claims. On April 8, 2008, the Company made the Fee Award to Counsel and the Incentive Award payments to plaintiffs’ counsel. On April 29, 2008, the Company began to issue advertising credits to the Class Members who filed timely claims. The Company recorded an estimate in accrued liabilities of the amount of the loss on settlement which management has determined is probable and estimable during the year ended December 31, 2007. This estimate may change as a result of the cost of the final settlement arrangement. In addition, during 2007 the Company recovered settlement proceeds from the insurance carrier, which exceeded the recorded estimate of the amount of loss on settlement. Due to the uncertainty relating to the ultimate settlement amount, the excess settlement proceeds have been recorded as an accrued liability at December 31, 2007 and at June 30, 2008.

Upon the completion of the thirty day appeals period, which ended on March 30, 2008, the Company on April 7, 2008 paid approximately $0.6 million of legal fees to the plaintiff’s counsel representing the Fees Award to Class Counsel and the Incentive Award as is stipulated in the Settlement Agreement.

9. Stockholders’ Equity

Common Stock

On February 13, 2008 the Company repurchased approximately 5.2 million of its shares via a modified Dutch Auction tender offer (“Offer”) at $3.40 per share for a total cost of approximately $17.9 million. The common stock accepted for purchase represented approximately 22.5% of our common stock issued and outstanding as of February 13, 2008. Shares acquired pursuant to the Offer were canceled and returned to the status of authorized but unissued stock and are available for the Company to issue without further stockholder action, except as required by applicable law or the rules of the NASDAQ or any securities exchange on which the shares may be listed, for various purposes including, without limitation, acquisitions of other businesses, raising additional capital and the satisfaction of obligations under existing or future employee benefit or compensation programs or stock plans or compensation programs for directors. The Company has no current plans for issuance of the shares purchased in the Offer.

On February 26, 2008, the Company’s Board of Directors authorized a stock repurchase program pursuant to which up to $5.0 million of its outstanding common stock may be repurchased through December 31, 2008. Under the program, the Company may purchase shares of common stock through the open market at the prevailing market price or in privately negotiated transactions. Repurchases may also be made under a rule 10b5-1 plan, which would permit shares to be repurchased when the Company might otherwise be precluded from doing so under insider trading laws. The timing and amount of repurchase transactions under this program will depend on market conditions and corporate considerations, and will be made in compliance with applicable federal and state securities laws and regulations. The Company intends to finance the stock repurchase from its existing cash, cash equivalents, and short-term investments balances. The stock repurchase program may be suspended or discontinued at any time.

On February 29, 2008, the Company agreed to purchase approximately 0.8 million shares at an average price of $3.51 per share, for a total price of approximately $2.8 million, as part of the repurchase program authorized on February 26, 2008. This trade settled on March 5, 2008. On April 10, 2008, the Company canceled the approximate 0.8 million shares, and returned the shares to the status of authorized but unissued stock which is available for the Company to issue without further stockholder action, except as required by applicable law or the rules of the NASDAQ or any securities exchange on which the shares may be listed, for various purposes including, without limitation, acquisitions of other businesses, raising additional capital and the satisfaction of obligations under existing or future employee benefit or compensation programs or stock plans or compensation programs for directors.

Stock Option Plans

In October 2000, the Company acquired Zeal Media, Inc. and assumed all the stock options outstanding under the 1999 Zeal Media, Inc. Stock Plan (the “Zeal Plan”). In April 2002, the Company acquired WiseNut, Inc. and assumed all the stock options outstanding under the WiseNut, Inc. 1999 Stock Incentive Plan (the “WiseNut Plan”). On June 19, 2007, the stockholders approved the LookSmart 2007 Equity Incentive Plan (the “2007 Plan”). The Company has reserved approximately 6.1 million and 8.3 million shares of common stock for issuance under its stock option plans at June 30, 2008 and 2007, respectively. Except for the one time share grants to certain executive officers that become exercisable over a two year period, outstanding stock options generally become exercisable over a three or four year period from the grant date and have a term of ten years. 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. For more information regarding these transactions, see the Company’s filings with the Securities and Exchange Commission on Form 8-K.

As of June 30, 2008, approximately 4.6 million stock options were outstanding and approximately 1.3 million shares remained available for grant under the Company’s plans.

Employee Stock Purchase Plan

In July 1999, the stockholders approved the 1999 Employee Stock Purchase Plan (the “ESPP Plan”). At June 30, 2008, a total of approximately 0.5 million shares of common stock were reserved for issuance under the ESPP Plan, plus annual increases at the Board’s discretion effective on January 1 of each year, beginning in 2000. As of June 30, 2008, approximately 0.5 million shares have been issued under the ESPP Plan and approximately 0.1 million shares remain available for issuance.

Share-Based Compensation

The Company accounts for employee stock options under SFAS 123R and its related interpretations. For the three and six months ended June 30, 2008, the Company recorded share-based compensation of approximately $0.6 million and $1.6 million, respectively, and approximately $0.6 million and $1.2 million for the three and six months ended June 30, 2007. Of these amounts, approximately $29 thousand and $0.1 million, and $35 thousand and $0.1 million, respectively, was capitalized related to the development of internal-use software in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (“SOP 98-1”).

Valuation Assumptions

As share-based compensation expense recognized in the Unaudited Condensed Consolidated Statement of Operations for the three and six months ended June 30, 2008 and 2007 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Volatility: The volatility factor was based on the Company’s historical stock prices over the most recent period commensurate with the estimated expected term of the stock options.

Risk-Free Interest Rate: The Company bases the risk-free interest rate used in the Black-Scholes valuation method on the implied yield currently available on U.S. Treasury issues with an equivalent remaining term of the share-based awards.

Expected Term: The Company’s expected term represents the period that the Company’s share-based awards are expected to be outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the share-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to the terms of its share-based awards.

Expected Dividend: The Black-Scholes valuation model calls for a single expected dividend yield as an input. The Company has not issued any dividends, and does not expect to issue dividends in the foreseeable future.

Annual Forfeiture Rate: When estimating pre-vesting forfeitures, the Company considers voluntary termination behavior as well as potential future workforce reduction programs.

The weighted average grant-date fair value of options granted in the three and six months ended June 30, 2008 was $2.15 and $2.27 per share, respectively, and $2.77 and $2.51 per share for the three and six months ended June 30, 2007, respectively.

The aggregate intrinsic value of options exercised for the three and six months ended June 30, 2008 was approximately $48 thousand and $0.1 million, respectively, and approximately $6 thousand and $49 thousand for the three and six months ended June 30, 2007, 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. Total unrecognized share-based compensation expense was approximately $4.8 million as of June 30, 2008, and the weighted average period over which it is expected to be recognized is 2.7 years.

Stock option activity under the plans during the periods indicated is as follows (in thousands except per share data):


	Outstanding Options Number of Shares		Weighted Average Exercise Price Per Share
Balance at December 31, 2007	4,341		$	4.65
Granted	927			3.55
Exercised	(6	)		2.71
Expired/forfeited	(490	)		4.10

Balance at March 31, 2008	4,772			4.50
Granted	26			4.06
Exercised	(37	)		3.17
Expired/forfeited	(121	)		4.41

Balance at June 30, 2008	4,640		$	4.51

The following table summarizes information about stock options outstanding at June 30, 2008 (in thousands except per share data):


		Outstanding				Exercisable
Range of Exercise Prices		Number Outstanding As of June 30, 2008	Weighted Average Remaining Contractual Life (in years)	Weighted Average Exercise Price	Aggregate Intrinsic Value	Number Exercisable As of June 30, 2008	Weighted Average Exercise Price	Aggregate Intrinsic Value
$ 2.27	$ 3.19	649	7.45	$ 2.88	$ 744	446	$ 2.92	$ 494
$ 3.20	$ 3.20	1,303	9.33	$ 3.20	1,082	198	$ 3.20	164
$ 3.21	$ 4.32	1,175	8.27	$ 3.76	386	570	$ 3.71	206
$ 4.33	$ 20.55	1,513	4.84	$ 6.91	—	1,083	$ 7.69	—

$ 2.27	$ 20.55	4,640	7.33	$ 4.51	$ 2,212	2,297	$ 5.39	$ 864

Aggregate intrinsic value represents the total pretax intrinsic value, based on the Company’s closing stock price on June 30, 2008 of $4.03 per share, which would have been received by option holders had all option holders exercised their options on that date.

As of June 30, 2008, the number of vested shares and unvested shares that were expected to vest was approximately 4.6 million, with a weighted-average exercise price of $4.51 per share, a weighted-average remaining contractual life of 7.3 years, and an aggregate intrinsic value of approximately $2.2 million.

As of June 30, 2007 there were approximately 3.4 million options outstanding and approximately 1.5 million options exercisable.

10. Comprehensive Loss

The components of comprehensive loss are as follows (in thousands):


	Three Months Ended June 30,					Six Months Ended June 30,
	2008		2007			2008		2007
Net loss	$	176	$	2,068		$	664	$	5,493
Other comprehensive loss:
Change in unrealized gain (loss) on securities, net		52		(8	)		16		(2	)

Comprehensive loss	$	124	$	2,076		$	648	$	5,495

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 Condensed Consolidated Financial Statements and the Notes to those statements which appear elsewhere in this Quarterly Report on Form 10-Q. The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believes,” “intends,” “expects,” “anticipates,” “plans,” “may,” “will” and similar expressions to identify forward-looking statements. Discussions containing forward-looking statements may be found in the material set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections of this report. All forward-looking statements, including, but not limited to, projections, expectations or estimates concerning our business, including demand for our products and services, mix of revenue sources, ability to control and/or reduce operating expenses, anticipated gross margins and operating results, cost savings, product development efforts, general outlook of our business and industry, future profits or losses, competitive position, share-based compensation, and adequate liquidity to fund our operations and meet our other cash requirements, are inherently uncertain as they are based on our expectations and assumptions concerning future events. These forward-looking statements are subject to numerous known and unknown risks and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including but not limited to, the possibility that we may fail to preserve our expertise in online advertising and publisher solutions product development, 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 sources of revenue other than our search advertising 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 attract and retain key personnel, that we may have unexpected increases in costs and expenses, or that one or more of the other risks described below in the section entitled “Risk Factors” and elsewhere in this report may occur.

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

Business Overview

LookSmart is an online search advertising and technology solutions company that provides relevant solutions for advertisers and publishers. Historically, LookSmart has provided three service offerings or “products”: 1) advertiser networks, 2) publisher solutions, and 3) consumer products.

together with, the various related websites and assets associated with the consumer products and international activities previously disposed of, met the discontinued operations criteria in accordance with the provisions of SFAS No. 144. The results of operations of assets to be disposed of, and of previously disposed assets, including related gains (losses) have been classified as discontinued operations for all periods presented in the accompanying Unaudited Condensed Consolidated Statements of Operations. See Footnotes 3, 4 and 9 for further details. At June 30, 2008, the Company continues to operate and own Furl and its intellectual property.

LookSmart was organized in 1996, as an Internal Revenue Code 26(A)(1)-subchapter (C) corporation, and is incorporated in the State of Delaware.

Critical Accounting Policies and Estimates

Our financial condition and results of operations are based upon certain critical accounting policies, which include estimates, assumptions, and judgments on the part of management. We base our 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, 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. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the period presented. Actual results may differ from those estimates. In management’s opinion, all adjustments necessary for a fair statement are reflected in the interim periods presented. All adjustments are of a normal or recurring nature.

The following discussion highlights those policies and the underlying estimates and assumptions, which we consider critical to an understanding of the financial information in this report.

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 impression-based revenue from banner advertisements, as well as revenue share from licensing of private-labeled versions of our products.

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 revenues. In accordance

with Emerging Issues Task Force Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent (“EITF 99-19”), 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 the AdCenter for Publishers. These arrangements include multiple elements: revenue-sharing based on the publishers’ customer’s monthly revenue generated through the AdCenter application; upfront fees; and license fees. We recognize revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (“SAB 104”), and Financial Accounting Standards Board Emerging Issues Task Force No. 00-21, Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). We recognize upfront fees over the term of the arrangement or the expected period of performance, 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.

Affiliate revenue is included in online advertising revenue and is based on commissions received for participation in affiliate programs. Affiliate programs are programs operated by affiliate network services or online merchants, in which merchants pay traffic providers on a cost-per-acquisition basis. By participating in affiliate programs, we generate revenue when Internet consumers make a purchase from a participating merchant’s website after clicking on the merchant’s listing in our search results. Revenues from affiliates are earned on a per-sale basis or as a percentage of sales rather than a per-click basis. Revenue is recognized in the period in which a merchant finalizes a sale and reports to us via our affiliate network.

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.

Deferred revenue is recorded when payments are received in advance of performance in underlying agreements. Customer deposits are recorded when customers make prepayments for online advertising.

Allowance for Doubtful Accounts

Determination of payments requires significant judgment on the part of management and includes performing initial and ongoing credit evaluations of customers. We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of our customers 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. We will record a reduction of our allowance for doubtful accounts if there is a significant improvement in collection rates or economic conditions are more favorable than we anticipated. Additional allowances for doubtful accounts may be required if there is deterioration in past due balances, if economic conditions are less favorable than we anticipated or for customer-specific circumstances, such as bankruptcy. Management’s judgment is required in the periodic review of whether a provision or reversal is warranted.

Valuation of Goodwill and Intangible Assets

We have recorded goodwill and intangible assets in connection with our business acquisitions. Management exercises judgment in the assessment of the related useful lives, fair value and recoverability of these assets. The majority of intangible assets are amortized over three to seven years, the period of expected benefit. Goodwill is not amortized. In accordance with SFAS 142, we periodically re-assess the valuation and asset lives of intangible assets to conform to changes in management’s estimates of future performance. Management considers existing and anticipated competitive and economic conditions in such assessments. Goodwill is reviewed for impairment at least annually and as a result of any event that significantly changes our business. The Company uses market capitalization, as well as cash flow forecasts and other market value indicators to review goodwill for impairment. Cash flow forecasts used in evaluation of goodwill are based on trends of historical performance and management’s estimate of future performance.

Deferred Taxes

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying values and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. If we operate at a loss or are unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to increase the valuation allowance against all or a significant portion of our deferred tax assets which could substantially increase our effective tax rate for such period. Alternatively, if our future taxable income is significantly higher than

expected and/or we are able to utilize our tax credits, we may be required to reverse all or a significant part of our valuation allowance against such deferred tax assets which could substantially reduce our effective tax rate for such period. Therefore, any significant changes in statutory tax rates or the amount of our valuation allowance could have a material impact on the value of our deferred tax assets and liabilities, and our reported financial results.

We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves are established when we believe that certain positions might be challenged despite our belief that our tax return positions are in accordance with applicable tax laws. Effective January 1, 2007, we adopted the provisions of FASB Interpretation No. 48 “Accounting for Uncertainty for Income Taxes-an interpretation of FASB Statement No. 109” (FIN 48).

Internal Use Software Development Costs

We account for internal use software in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (“SOP 98-1”). In accordance with the capitalization criteria of SOP 98-1, we have capitalized external direct costs of materials and services consumed in developing and obtaining internal-use computer software and the payroll and payroll-related costs of employees who devote time to the internal use computer software project.

Management’s judgment is required in determining the point at which various projects enter the stages at which costs may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the estimated useful lives over which the costs are amortized. We expect to continue to invest in internally developed software and to capitalize costs in accordance with SOP 98-1.

Restructuring Charges

We have recorded a restructuring accrual related to closing certain leased facilities in accordance with SFAS 146. Management’s judgment is required in estimating when the redundant facilities will be subleased and at what rate they will be subleased.

Share-Based Compensation

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) (SFAS 123R), Share-Based Payment, which revised SFAS 123, Accounting for Share-based Compensation . SFAS 123R requires all share-based payment transactions with employees, including grants of employee stock options and employee stock purchases related to the Employee Stock Purchase Plan to be recognized as compensation expense over the requisite service period based on their relative fair values. SFAS 123R is a very complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility and expected option lives, as well as expected option forfeiture rates, to value equity-based compensation. SFAS 123R requires the recognition of the fair value of stock compensation in net income (loss).

Recent Accounting Pronouncements

For a description of recent accounting pronouncements, see Note 1 (Summary of Significant Accounting Policies) in the Notes to the Unaudited Condensed Consolidated Financial Statements.

Results of Operations

Overview of the Three and Six Months Ended June 30, 2008

The following table sets forth selected information concerning our results of operations as a percentage of consolidated net sales for the periods indicated:


	Three Months Ended June 30,				Six Months Ended June 30,
	2008		2007		2008		2007
Revenue	100.0	%	100.0	%	100.0	%	100.0	%
Cost of revenue	60.4		54.3		59.1		55.4

Gross profit	39.6		45.7		40.9		44.6
Operating expenses:
Sales and marketing	11.7		16.5		12.2		17.1
Product development	16.6		21.8		16.6		23.8
General and administrative	13.8		21.6		15.1		23.3
Restructuring costs	(0.8	)	—		(0.4	)	—

Total operating expenses	41.3		59.9		43.5		64.2
Loss from operations	(1.7	)	(14.2	)	(2.6	)	(19.6	)
Non-operating income, net	1.5		3.8		2.0		4.1

Loss from continuing operations before income taxes	(0.2	)	(10.4	)	(0.6	)	(15.5	)
Income tax expense	—		—		—		—

Loss from continuing operations	(0.2	)	(10.4	)	(0.6	)	(15.5	)
Loss from discontinued operations, net of tax	(0.8	)	(4.9	)	(1.3	)	(6.1	)

Net loss	(1.0	)%	(15.3	)%	(1.9	)%	(21.6	)%

Revenues

Revenues are derived from LookSmart’s two service offerings or “products”: Advertiser Networks and Publisher Solutions.

LookSmart recognized approximately $17.1 million of total revenue during the three months ended June 30, 2008, up 27% from the approximate $13.5 million recognized during the three months ended June 30, 2007. The approximate $3.6 million change in total revenue was driven by:

•

Growing our ad network. Total paid clicks for the second quarter of 2008 were approximately 195 million compared to approximately 120 million in the second quarter of 2007, an increase of 62%. On a year-to-date basis total paid clicks were approximately 346 million in 2008 compared to approximately 213 million in 2007. In the second quarter of 2008, our average revenue per click (“RPC”) was $0.08 per click, compared to $0.10 per click for the second quarter of 2007. On a year-to-date basis our average RPC for 2008 was $0.09 per click, compared to $0.11 per click for 2007. Average RPC decreased in the second quarter 2008 as compared to 2007 primarily as a result in the mix of direct and intermediary sales channels. We continue to drive growth in paid clicks through our ad sales efforts and through our ongoing ad network optimization efforts as well as growth in our advertiser base.

•

Distributing syndicated solutions for publishers. We continue to focus on improving our private-labeled AdCenter for Publishers. The release of a solution for publishers’ unsold ad inventory known as “Platform Backfill” in the second quarter of 2007 is an example of improvements of the private-labeled AdCenter for Publishers.

•

Exiting Consumer Business. In August 2007, the Company’s management made the decision to exit the consumer products activities and to sell or otherwise dispose of some of the various related websites and assets associated with the consumer properties revenue stream. In 2008 the results of operations to be disposed of and previously disposed assets, including related gains (losses) have been classified as discontinued operations for all periods presented in the accompanying Unaudited Consolidated Statement of Operations.

Total revenues, and revenues from Advertiser Networks and Publisher Solutions for the three and six months ended June 30, 2008 and 2007 were as follows (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2008		2007		Change		2008		2007		Change
Online advertising revenues:
Advertiser Networks	$	15,738	$	12,148	30	%	$	31,540	$	22,837	38	%
Publisher Solutions		1,354		1,345	1	%		3,096		2,579	20	%

Total revenues	$	17,092	$	13,493	27	%	$	34,636	$	25,416	36	%

For the six months ended June 30, 2008 LookSmart recognized approximately $34.6 million of total revenue, up approximately $9.2 million, or 36% from the approximate $25.4 million recognized during the six months ended June 30, 2007.

LookSmart recognized approximately $15.7 million of revenue from Advertiser Networks during the three months ended June 30, 2008, up 30% from the approximate $12.1 million recognized during the three months ended June 30, 2007. The second quarter 2008 revenue includes approximately $0.2 million resulting from the resolution of an amount specifically reserved in 2007. Revenues from Advertiser Networks increased in the second quarter of 2008 by approximately $3.6 million, primarily as a result of an increase in revenue from new advertising customers, up-selling on existing large advertisers, an increase in the volume of total paid clicks as a result of increase in advertisers, improvements in quality of the Ad Network platform, performance optimization and better match rate. Total paid clicks totaled approximately 195 million for the second quarter of 2008, as compared to approximately 120 million for the second quarter of 2007, an increase of 62%. Average RPC decreased in the second quarter of 2008 to $0.08 from $0.10 in the second quarter of 2007 primarily as a result of shifts in the mix of direct and intermediary sales channels.

LookSmart recognized approximately $1.4 million of revenue from Publisher Solutions during the three months ended June 30, 2008, roughly equivalent to the approximate $1.4 million recognized during the three months ended June 30, 2007. During the six months ended June 30, 2008, LookSmart realized approximately $3.1 million of revenue from Publisher Solutions, up 20%, or approximately $0.5 million, from the approximate $2.6 million realized in the same period of the prior year. Year to date revenues from Publisher Solutions were impacted by an increase in revenue attributable to one significant publisher customer in the first three months of 2008.

Revenue amounts reflect the reclassification of approximately $26 thousand and $0.1 million, and approximately $1.1 million and $2.4 million of revenue of various related websites and assets associated with the consumer products activities to discontinued operations for the three and six months ended June 30, 2008 and 2007, respectively. See Footnote 2 under Notes to the Unaudited Condensed Consolidated Financial Statements for further details.

Cost of Revenues and Gross Margin

Cost of revenues consists of TAC, the costs paid to our distribution network partners, and other. Other costs of revenue consist of connectivity costs, expenses relating to hosting advertising operations, commissions paid to advertising agencies and credit card fees and were as follows (in thousands):


	Three Months Ended June 30,						Change		Six Months Ended June 30,						Change
	2008			2007			Change		2008			2007			Change
Traffic acquisition costs	$	9,743		$	7,060		38	%	$	19,455		$	13,392		45	%
Percentage of online advertising revenue		61.9	%		58.1	%				61.7	%		58.6	%
Other costs		575			270		113	%		1,021			681		50	%

Total cost of revenues	$	10,318		$	7,330		41	%	$	20,476		$	14,073		46	%
Percentage of total revenue		60.4	%		54.3	%				59.1	%		55.4	%

Our total cost of revenue during the three months ended June 30, 2008 was approximately $10.3 million, up approximately $3.0 million, or 41% from the approximate $7.3 million in the three months ended June 30, 2007. Total cost of revenue for the six months ended June 30, 2008 was approximately $20.5 million, up approximately $6.4 million, or 46% from the approximate $14.1 million in the six months ended June 30, 2007. Periodic cost of revenue is dependent upon volume of traffic, traffic acquisition costs, and other costs of revenue.

Total cost of revenue amounts reflect the reclassification of approximately $0.1 million and $21 thousand, and $0.9 million and $1.8 million of cost of revenue of various related websites and assets associated with the consumer products activities to discontinued operations for the three and six months ended June 30, 2008 and 2007, respectively. See Footnote 2 under Notes to the Unaudited Condensed Consolidated Financial Statements for further details.

Our TAC during the three months ended June 30, 2008 were approximately $9.7 million, up approximately $2.7 million, or 38% from the approximate $7.1 million in the three months ended June 30, 2007. TAC increased in the second quarter of 2008 compared to the second quarter of 2007 primarily due to:

•

Higher sales volumes and a deliberate operating decision to accept higher TAC in order to drive higher top-line advertising revenues and bottom-line profit contribution in the Advertiser Network.

•

Higher TAC were partially offset by increased contribution from the Publisher Solutions business.

TAC for the first six months of 2008 were approximately $19.5 million, up 45%, or approximately $6.1 million, from the approximate $13.4 million in first six months of 2007.

Our other costs of revenue during the three months ended June 30, 2008 was approximately $0.6 million, up approximately $0.3 million, or 113%, from the approximate $0.3 million in the three months ended June 30, 2007. Other costs increased in the second quarter of 2008 compared to the second quarter of 2007 primarily due to higher line rental charges. Other costs of revenue expense for the first six months of 2008 were approximately $1.0 million, up 50%, or approximately $0.3 million, from the approximate $0.7 million in the first six months of 2007.

Gross margin of 39.6% in the second quarter of 2008 declined 6.1 percentage points from the 45.7% gross margin in the second quarter of 2007, with year-to-date gross margin of 40.9% down 3.7 percentage points from the 44.6% achieved in the first six months of 2007.

Operating Expenses

Operating expenses consist of sales and marketing, product development, general and administrative, restructuring costs, impairment charges, share-based compensation, and other and were as follows (in thousands):


	Three Months Ended June 30,					Change		Six Months Ended June 30,					Change
	2008			2007		Change		2008			2007		Change
Sales and marketing	$	1,994		$	2,223	(10	)%	$	4,210		$	4,351	(3	)%
Product development		2,833			2,943	(4	)		5,738			6,044	(5	)
General and administrative		2,362			2,918	(19	)		5,234			5,914	(12	)
Restructuring costs		(135	)		—	NA			(135	)		—	NA

Total operating expense	$	7,054		$	8,084	(13	)%	$	15,047		$	16,309	(8	)%

Share-based compensation expense was allocated as follows (in thousands):


	Three Months Ended June 30,						Change		Six Months Ended June 30,						Change
	2008			2007			Change		2008			2007			Change
Sales and marketing	$	107		$	71		51	%	$	216		$	113		91	%
Product development		170			162		5	%		349			275		27	%
General and administrative		324			364		(11	)%		1,049			670		57	%
Loss from discontinued operations		12			48		(75	)%		23			100		(77	)%

Total share-based compensation		613			645		(5	)%		1,637			1,158		41	%
Less amounts capitalized as software development costs		(29	)		(35	)	(17	)%		(54	)		(53	)	2	%

Total share-based compensation expense	$	584		$	610		(4	)%	$	1,583		$	1,105		43	%

Sales and Marketing

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

Our sales and marketing expense during the three months ended June 30, 2008 was approximately $2.0 million, down 10% from the approximate $2.2 million in the three months ended June 30, 2007. Sales and marketing expenses in the second quarter of 2008 decreased approximately $0.2 million compared to the second quarter of 2007 primarily due to:

•

Lower spending on marketing programs and events, down approximately $0.3 million from the second quarter of 2007,

•

Lower facilities expense of approximately $0.1 million, and

•

Higher travel expense of approximately $0.1 million.

Our sales and marketing expense during the six months ended June 30, 2008 was approximately $4.2 million, down 3% from approximately $4.4 million year-to-date in 2007. Sales and marketing expenses year-to-date decreased approximately $0.2 million compared to the same six month period in 2007, due to:

•

Lower spending on marketing programs and events, down approximately $0.8 million in the first six months of 2008 from the first six months of 2007,

•

Higher labor costs of approximately $0.3 million, primarily due to an increase in bonus expense and certain operational personal previously included in general and administrative expenses move to sales,

•

Higher share-based compensation expense of approximately $0.1 million,

•

Higher travel costs of approximately $0.1 million, and

•

An increase in bad debt expense of approximately $0.1 million.

For the three months ended June 30, 2008 and 2007, approximately $0.1 million and approximately $0.1 million, respectively, of share-based compensation was included in sales and marketing costs. Share-based compensation included in sales and marketing costs was approximately $0.2 million and $0.1 million, respectively, for the six months ended June 30, 2008 and 2007.

Product Development

Product development costs include all costs related to the continued development and enhancement of our core technology products such as the AdCenter for Publishers. These costs include salaries and associated costs of employment, including share-based compensation, overhead, facilities and amortization of intangible assets. 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. Software licensing and computer equipment depreciation related to supporting product development functions are also included in product development expenses.

Capitalized software development costs include the costs to develop software for internal use, excluding costs associated with research and development, training and testing and were as follows (in thousands):


	Three Months Ended June 30,						Change		Six Months Ended June 30,						Change
	2008			2007			Change		2008			2007			Change
Capitalized software development costs	$	(441	)	$	(325	)	(36	)%	$	(650	)	$	(530	)	(23	)%
Other product development costs		3,274			3,268		—	%		6,388			6,574		(3	)%

Total product development expenses	$	2,833		$	2,943		(4	)%	$	5,738		$	6,044		(5	)%

Our product development expense during the three months ended June 30, 2008 was approximately $2.8 million, down 4% from approximately $2.9 million in the three months ended June 30, 2007. Product development expenses in the three months ended June 30, 2008 decreased approximately $0.1 million compared to the same period in 2007. Product development expenses in the second quarter of 2008 were predominantly driven by:

•

Increased depreciation, up approximately $0.4 million, due to higher equipment purchases,

•

Decreased labor costs of approximately $0.2 million. This was primarily due to a decrease in headcount partially as a result of the exit from consumer product activities, which resulted in a sale or disposal of the various related websites and assets associated with those activities, and the resignation of the Chief Technical Officer in August 2007,

•

A decrease of approximately $0.1 million in facilities costs due to a lower headcount and the subleasing of part of our office space starting in the fourth quarter of 2007,

•

Higher capitalized software values, up approximately $0.1 million versus the second quarter of 2007, and

•

Lower spending on computer and office supplies, down approximately $0.1 million from the prior year quarter, predominantly due to lower headcount.

Our product development expense during the six months ended June 30, 2008 was approximately $5.7 million down 5% from approximately $6.0 million year-to-date in 2007. Product development expenses year-to-date decreased approximately $0.3 million compared to the same period in 2007, due to:

•

Higher depreciation costs of approximately $0.6 million due to higher equipment purchases,

•

Decreased labor costs of approximately $0.5 million. Decreased labor costs were due to: a) headcount declines in continuing operations, b) reductions of headcount due to the Company’s exit from its consumer products activities, c) a reduction in work force in the third quarter of 2007, and d) the resignation of the Chief Technical Officer in August of 2007, among other factors,

•

A decrease of approximately $0.3 million in facilities costs due to lower headcount and the subleasing of part of our office space starting in the fourth quarter of 2007,

•

Higher capitalized software development costs of approximately $0.1 million, and

•

Higher professional services of approximately $0.1 million relating to first level support of our operations center.

Total product development costs reflect the reclassification of approximately $0.2 million and $0.5 million, and $0.9 million and $2.0 million of product development costs of various related websites and assets associated with the consumer products activities to discontinued operations for the three and six months ended June 30, 2008 and 2007, respectively. See Footnote 2 under Notes to the Unaudited Condensed Consolidated Financial Statements for further details.

For the three months ended June 30, 2008 and 2007, approximately $0.2 million of share-based compensation was included in both three month periods in product development costs. Share-based compensation included in product development costs was approximately $0.3 million for both the six months ended June 30, 2008 and 2007.

General and Administrative

General and administrative expenses include costs of executive management, human resources, finance, legal and facilities personnel. These costs include salaries and associated costs of employment, including share-based compensation, overhead, facilities and allocation of depreciation. General and administrative expenses also include legal, insurance, tax and accounting, consulting and professional services fees.

Our general and administrative expense during the three months ended June 30, 2008 was approximately $2.4 million, down 19% from approximately $2.9 million in the three months ended June 30, 2007. General and administrative expenses in the second quarter of 2008 decreased approximately $0.5 million compared to the second quarter of 2007 primarily due to:

•

Lower labor costs of approximately $0.5 million due to a decrease in headcount, which included certain operational personnel previously included in general and administrative expenses, mover to sales which was partially offset by increased costs of temporary help and consulting of approximately $0.2 million,

•

Lower costs for outside legal services of approximately $0.2 million, as the Company had fewer corporate development activities.

•

A decrease of approximately $0.1 million in facilities costs versus the second quarter of 2007 due to subleasing part of our office space starting in the fourth quarter of 2007.

Our general and administrative expense during the six months ended June 30, 2008 was approximately $5.2 million, down 12% from approximately $5.9 million year-to-date in 2007. General and administrative expenses year-to-date decreased approximately $0.7 million compared to 2007, due to:

•

Increased costs of temporary help and consulting of approximately $0.3 million, which was partially offset by lower labor costs of approximately $0.3 million,

•

Lower costs for outside legal services of approximately $0.3 million primarily due to fewer corporate development activities,

•

Lower facilities costs of approximately $0.2 million, and

•

Lower expenses for bonuses and other employee costs of approximately $0.1 million.

For the three months ended June 30, 2008 and 2007, approximately $0.3 million and $0.4 million, respectively, of share-based compensation was included in general and administrative costs. Share-based compensation included in general and administrative costs were approximately $1.1 million and $0.7 million, respectively, for the six months ended June 30, 2008 and 2007.

Total general and administrative costs reflect the reclassification of approximately $5 thousand and $35 thousand, and $11 thousand and $22 thousand of general and administrative costs of various related websites and assets associated with the consumer products activities to discontinued operations for the three and six months ended June 30, 2008 and 2007, respectively. See Footnote 2 under Notes to the Unaudited Condensed Consolidated Financial Statements for further details.

Other Operating Loss, Net includes licensing and royalty fees for LookSmart intellectual property assets provided to, or used by other firms.

Restructuring Costs

During 2003, the Company vacated portions of its leased headquarter office facilities, and incurred lease restructuring costs related to closing these facilities.

In the second quarter of 2008 we subleased approximately 6,500 square feet for which we previously took a restructuring charge. The additional sublease resulted in a onetime reduction of approximately $0.1 million in the deferred rent liability with the offset being a restructuring cost benefit.

Loss from Operations (in thousands)


	Three Months Ended June 30,				Change		Six Months Ended June 30,				Change
	2008		2007		Change		2008		2007		Change
Loss from operations	$	280	$	1,921	(85	%)	$	887	$	4,966	(82	%)

Our loss from operations during the three months ended June 30, 2008 was approximately $0.3 million, down from losses of approximately $1.9 million in the three months ended June 30, 2007. For the six months ended June 30, 2008, our losses from operations were approximately $0.9 million, down from losses of approximately $5.0 million in the six months ended June 30, 2007. Loss from operations decreased approximately $1.6 million and $4.1 million, respectively, in the three and six months of 2008 compared to 2007 due to the factors discussed above.

Our loss from operations for the three and six months ended June 30, 2008 includes three significant items that reduced the loss by approximately $0.4 million. These items consisted of:

•

Increased revenue of approximately $0.2 million resulting from the resolution of an amount specifically reserved in 2007,

•

Decreased facility costs of approximately $0.1 million resulting from the recovery of overcharges, and

•

Restructuring charge benefit of approximately $0.1 million resulting from the sublease of additional space.

Non-Operating Income, net

Non-operating income (loss), net is primarily comprised of interest income and was as follows (in thousands).


	Three Months Ended June 30,				Change		Six Months Ended June 30,				Change
	2008		2007		Change		2008		2007		Change
Non-operating income, net	$	247	$	518	(52	)%	$	680	$	1,033	(34	)%

Interest income decreased in the second quarter of 2008 compared to the second quarter of 2007 primarily due to lower investment balances as the Company utilized its capital to repurchase its stock in the first half of 2008, a decrease in interest rates, and a change in the mix of our investment portfolio. During the first six months of 2008, LookSmart repurchased a total of approximately 6.0 million shares of its common stock for a total cost of approximately $20.8 million. These shares represented 26.0% of the total shares outstanding as of December 31, 2008.

Income Tax Expense

The effective tax rate in upcoming quarters and for the year ended December 31, 2008 may vary due to a variety of factors, including, but not limited to, the relative income contribution by tax jurisdiction, changes in statutory tax rates, the amount of tax exempt interest income generated during the year and any non-deductible items related to acquisitions or other non-recurring charges. For the purposes of calculating its estimated periodic tax obligations, we currently estimate our full-year 2008 tax rate at

4.2%. The effective tax rate for the year ended December 31, 2007 was 7.6%. The majority of the tax expense in both years is attributable to alternative minimum federal and state taxes. The realized effective tax rate in 2007 was heavily influenced by the gain on sale of FindArticles and was as follows (in thousands):


	Three Months Ended June 30,				Change		Six Months Ended June 30,				Change
	2008		2007		Change		2008		2007		Change
Income tax expense	$	7	$	—	NA	%	$	14	$	6	133	%

There were no unrecognized tax benefits for the three months ended June 30, 2008.

Deferred tax assets on the balance sheet were approximately $73.6 million and $73.8 million at June 30, 2008 and December 31, 2007, respectively. These were offset by valuation allowances of approximately $73.6 million and $73.8 million at June 30, 2008 and December 31, 2007, respectively.

Loss from Discontinued Operations, Net of Tax (in thousands)


	Three Months Ended June 30,				Change		Six Months Ended June 30,				Change
	2008		2007		Change		2008		2007		Change
Loss from discontinued operations, net of tax	$	136	$	665	80	%	$	443	$	1,554	71	%

The following table reflects revenue, gross profit, operating expenses, pre-tax income (loss) from discontinued operations and gain (loss) on sale of discontinued operations for the three and six months ended June 30, 2008 and June 30, 2007 (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Revenue	$	26		$	1,131		$	52		$	2,434

Gross profit	$	80		$	280		$	31		$	672
Product development expenses		189			946			520			2,018
General and administrative expenses		(5	)		73			35			85
Impairment charges		381			—			381			—
Non-operating income, net		9			—			9			—

Pretax net loss (excluding gain on disposal)		(476	)		(739	)		(896	)		(1,431	)

Gain (loss) on disposal		340			74			453			(123	)

Net loss from discontinued operations, net of tax	$	(136	)	$	(665	)	$	(443	)	$	(1,554	)

At June 30, 2008 certain assets relating to Furl have been accounted for under the guidance of SFAS 144 as “assets held for sale,” and have been classified as such on the Company’s Unaudited Condensed Consolidated Balance Sheet (in thousands):


	June 30, 2008
Property and equipment, net	$	70
Capitalized software, net		739
Goodwill		104
Intangibles, net		97

Total assets held for sale	$	1,010

In 2007, the Company’s management made the decision to exit certain consumer products activities and to sell or otherwise dispose of the various related websites and assets associated with those activities. During 2007 the Company sold FindArticles, the assets relating to Grub, and the websites associated with Zeal and completed the shutdown of the Wisenut website and search functionality. In the first quarter of 2008 the Company’s management made the decision to exit the remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. Additionally, during the second quarter of 2008 Furl assets have been accounted for under the guidance of SFAS 144 Accounting for the Impairment or Disposal of Long-Lived assets

(“SFAS 144”) as “assets held for sale,” and these, together with, the various related websites and assets associated with the consumer products activities previously disposed of, met the discontinued operations criteria in accordance with the provisions of SFAS No. 144. The results of operations of assets to be disposed of, and of previously disposed assets, including related gains (losses) have been classified as discontinued operations for all periods presented in the accompanying Unaudited Condensed Consolidated Statements of Operations.

At June 30, 2008, the Company continues to own the Wisenut search engine technology and its intellectual property rights in such technology and other assets and owns and operates Furl.

During the three months ended June 30, 2008 and 2007 the Company recorded an additional credit in general and administrative expenses of discontinued operations of approximately $6 thousand and expenses of approximately $0.1 million relating to the finalization of the liquidation of various foreign operations in the first quarter of 2008. Additional expenses relating to the finalization of the liquidation of various foreign operations were approximately $29 thousand and approximately $0.1 million for the six months ended June 30, 2008 and 2007, respectively. The Company expects to finalize the dissolution of these entities during 2008.

During the three months ended June 30, 2008, management estimated that the goodwill assigned to Furl was impaired based on a preliminary analysis of goodwill impairment performed due to the existence of indicators of impairment, such impairment analysis has not been finalized due to additional time required to perform a complete analysis. Any significant adjustments to the initial approximately $0.4 million impairment estimate resulting from finalizing the impairment analysis will be reflected in subsequent reporting periods.

The gain (loss) on disposal consists of the following (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2008		2007		2008		2007
Other consumer assets	$	120	$	74	$	233	$	(123	)
Wisenut		220		—		220		—

	$	340	$	74	$	453	$	(123	)

Liquidity and Capital Resources

LookSmart’s primary sources of liquidity during the six months ended June 30, 2008 were existing cash, cash equivalents, short term investments as well as cash received from the collection of accounts receivable balances generated from sales in the first and second quarters of 2008.

Cash and Cash Equivalents

Cash and related balances are (in thousands):


	June 30, 2008			December 31, 2007			Change
Cash and cash equivalents	$	13,321		$	35,743		$	(22,422	)
Short-term investments		21,101			20,464			637

Total	$	34,422		$	56,207		$	(21,785	)

% of total assets		59	%		70	%

Total Assets	$	58,436		$	80,293

Financial Condition

We believe our current cash, cash equivalents and short term investments, anticipated cash flow from operations and future seasonal borrowings, if any, will be sufficient to meet our working capital and capital requirements through at least June 30, 2009, if not longer. 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, such as the entry into agreements requiring large cash payments or 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.

Cash and cash equivalents decreased to approximately $34.4 million during the six months ended June 30, 2008 from approximately $56.2 million at December 31, 2007 primarily due the Company’s use of capital to buy back its stock in the first six months of 2008. During the first half of 2008, the Company repurchased approximately 6.0 million shares for a total cost of approximately $20.8 million. This amount is included in the cash used in financing activities.

In summary, our overall uses during the six months ended June 30, 2008 as compared to the six months ended June 30, 2007 were (in thousands):


	June 30,
	2008			2007			Change
Net cash used in operating activities	$	(911	)	$	(1,888	)	$	977
Net cash used in investing activities		(665	)		(7,631	)		6,966
Net cash provided by (used in) financing activities		(20,846	)		321			(21,167	)

Decrease in cash and cash equivalents	$	(22,422	)	$	(9,198	)	$	(13,224	)

We believe that our cash flow is seasonal and a large portion of our revenue historically occurs in the last quarter of the year as our customers expand advertising for the holiday selling season. Cash used in operations is typically the highest in the first quarter as we see reduced demand for our service offerings. The following table summarizes our quarterly cash provided by or (used in) operating activities that illustrate the seasonality of our business (in thousands):


	Cash Flow From Operating Activities
	2008			2007			2006
1st Quarter	$	(2,052	)	$	(1,967	)	$	(3,953	)
2nd Quarter		1,141			79			(1,971	)
3rd Quarter		NA			(994	)		(2,222	)
4th Quarter		NA			936			1,834

Total	$	(911	)	$	(1,946	)	$	(6,312	)

We have outstanding standby letters of credit (“SBLC”) of approximately $1.1 million at June 30, 2008 related to security of a building lease and security for payroll processing services. The SBLC contains two financial covenants. As of June 30 2008, we were in compliance with both required covenants.

On April 6, 2007, the Company entered into a master equipment lease agreement with CNB for an amount of up to $5.0 million for the purchase of technical equipment. This line of credit expired on March 30, 2008 and was available for equipment leases with rental terms from 36 to 48 months. Interest on the capital lease was calculated using an interest rate of 7.38% per annum.

On April 1, 2008, the Company renewed the master equipment lease agreement with CNB, which expired on March 30, 2008. As of June 30, 2008, we had drawn down approximately $1.4 million from the available lease line of credit and repaid approximately $0.2 million of the capital lease.

During the first half of 2008 the Company repurchased approximately 6.0 million shares for a total cost of approximately $20.8 million. This amount is included in the cash used in financing activities.

Operating Activities

We used approximately $0.9 million in operating activities during the six months ended June 30, 2008. This compares to us using approximately $1.9 million in operating activities during the same period in the prior year. Therefore, in absolute dollars, we used approximately $1.0 million less in operations during the six months ended June 30, 2008 compared to the same period in the prior year. This reduction in operating cash use was primarily due to a decrease in the reported net loss during the six months ended June 30, 2008 compared to the same period in the prior year. During the six months ended June 30, 2008, we decreased our net loss by approximately $4.8 million to a net loss of approximately $0.7 million from a net loss of approximately $5.5 million during the same period in the prior year. The reduction in reported net loss was partially offset by an increase in the cash we used to pay our accrued expenses and other current liabilities. During the six months ended June 30, 2008 we used approximately $2.8 million to decrease our accrued expenses and other current liabilities compared to leveraging (or increasing) our accrued expenses and current liabilities by approximately $1.0 million during the six months ended June 30, 2007. In absolute dollars, this operating decision increased our relative cash use by approximately $3.7 million during the six months ended June 30, 2008 compared to the same period in the prior year.

Investing Activities

We used approximately $0.7 million in investing activities during the six months ended June 30, 2008. This compares to us using approximately $7.6 million in investing activities during the same period in the prior year. Therefore, in absolute dollars, we used approximately $7.0 million less in investing activities during the six months ended June 30, 2008 compared to the same period in the prior year. This reduction in investing cash use was primarily due to an increase in proceeds from sale and maturities of short term investments coupled with an increase in proceeds from sale of certain consumer assets partially offset by an increase in the purchase of short term investments. During the six months ended June 30, 2008 we received approximately $14.6 million more in the proceeds mentioned above. Specifically, proceeds from sale and maturities of short term investments increased by approximately $13.5 million to approximately $23.9 million received in the first six months of 2008 compared to approximately $10.3 million received in the same period in the prior year. Similarly, we generated proceeds of approximately $1.0 million from the sale of certain consumer assets in the first six months of 2008 where we had no such proceeds during the same period in the

prior year. The increase in proceeds mentioned above were partially offset by a approximately $7.9 million increase in our purchases of short term investments to approximately $24.5 million during the six months ended June 30, 2008 from approximately $16.6 million during the same period in the prior year.

LookSmart currently maintains no short or long-term investments in Auction Rate Securities.

Financing Activities

We used approximately $20.8 million in financing activities during the six months ended June 30, 2008. This compares to us generating approximately $0.3 million in financing activities during the same period in the prior year. Therefore, in absolute dollars, we used approximately $21.2 million more in financing activities during the six months ended June 30, 2008 compared to the same period in the prior year. This increase in financing cash use was primarily due our stock repurchase program. During the six months ended June 30, 2008, we used approximately $20.8 million in repurchasing our common stock via a modified Dutch Auction tender offer, as more fully described in Footnote 9 to the financial statements, compared to no such expenditures during the same period in the prior year.

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, 2007, we believe that there have been no significant changes in contractual obligations or commercial commitments.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

Our exposure to market risk for interest rate changes relates primarily to our cash equivalents, short-term and any long-term investments. We had no derivative financial instruments as of June 30, 2008 or December 31, 2007. We invest our excess cash in debt and equity instruments of high-quality corporate issuers with original maturities greater than three months and effective maturities less than two years. The amount of credit exposure to any one issue, issuer and type of instrument is limited. These securities are subject to interest rate risk and vary in value as market interest rates fluctuate. During the three and six months ended June 30, 2008, the effects of changes in interest rates on the fair market value of our marketable investment securities and our earnings were not material. Further, we believe that the impact on the fair market value of our securities and our earnings from a hypothetical 10% change in interest rates would not be significant.

Our interest rate risk relates primarily to our investment portfolio, which consisted of approximately $9.4 million in cash equivalents and approximately $21.1 million in short-term investments as of June 30, 2008. In a declining interest rate environment, as short-term investments mature, reinvestment occurs at less favorable market rates. Given the short term nature of certain investments, anticipated declining interest rates will negatively impact our investment income.

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

During the period covered by this report, there were no changes in the Company’s internal control over financial reporting that have materially affected, or could be reasonably likely to materially affect, the registrant’s internal control over financial reporting. During the course of our general evaluation of internal controls for the quarter ended June 30, 2008 and the year ended December 31, 2007 close process, there were one and two significant deficiencies respectively identified in the design and operation of our internal controls. We are in the process of remediating these significant deficiencies and will continue our work to reduce the occurrence of future significant deficiencies.

Limitations on the Effectiveness of Controls

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

PART II

ITEM 1.

LEGAL PROCEEDINGS

Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc

Additionally, we are 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, we do not expect resolution of these matters to have a material adverse impact on our consolidated results of operations, cash flows or financial position unless stated otherwise. However, an unfavorable resolution of a matter could, depending on its amount and timing, materially affect our future results of operations, cash flows or financial position in a future period. Regardless of the outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors.

ITEM 1A.

RISK FACTORS

Other than certain updates to our risk factors, including our risk factors regarding our ability to attract and retain key personnel, our potential liability for claims related to our products and services, and accounting for employee stock options using the fair value method as set forth below, there have been no material changes to the risk factors that are included in our Annual Report on Form 10-K for the year ended December 31, 2007 that could affect our business, results of operations or financial condition.

You should carefully consider the risks described below before making an investment decision regarding our common stock. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed. In that case, the trading price of our common stock could decline and our investors could lose all or part of their investment. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations.

Risks Related to our Business

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

The display of search advertisements accounted for substantially all of our revenues for the three months ended June 30, 2008. Our success depends upon advertisers choosing to use, and distribution network partners choosing to distribute, our search advertising networks products. Search advertisers and distribution network partners may not adopt our products at projected rates, or changes in market conditions may adversely affect the use or distribution of search advertisements. Because of our revenue concentration in the online search advertising business, such shortfalls or changes could have a negative impact on our financial results. Also, many of our products are offered to website publishers who use them to display or generate revenue from their online advertisements. Our overall revenue is concentrated with one customer representing 16% and one customer representing 12% of overall revenue for the three months ended June 30, 2008. If we are unable to generate significant revenue from our online listings advertising business, or if market conditions adversely affect the use or distribution of online listings advertisements generally, our results of operations, financial condition and/or liquidity will suffer.

We rely primarily on our network of distribution network partners to generate paid clicks; if we are unable to maintain or expand this network, our ability to generate revenue may be seriously harmed

The success of our online search advertisement products depends in large part on the size and quality of our distribution network. We may be unable to maintain or add distribution network partners of satisfactory quality in our distribution network at reasonable revenue-sharing rates, or at all. Our distribution network is concentrated, with three largest distribution network partners in total accounting for approximately 37% of our revenue for the three months ended June 30, 2008. If we lose any significant portion of our distribution network, we would need to find alternative sources of quality click traffic to replace the lost paid clicks. In the past, we have lost portions of our distribution network. Although alternate sources of click traffic are currently available in the market, they may not be available at reasonable prices, they will likely be subject to competition from various paid search providers, and they may be of lower quality. There is fierce competition among advertising networks to sign agreements with traffic providers. We may be unable to negotiate and sign agreements with quality traffic providers on favorable terms, if at all. If we are unsuccessful in maintaining and expanding our distribution network, then our ability to generate revenue may be seriously harmed.

We rely on our AdCenter for Publisher customers to generate paid clicks; if we are unable to maintain these relationships or add additional customers, our ability to generate revenue may be seriously harmed

The success of our Company depends on our ability to sign and maintain license and revenue share arrangements with our AdCenter for Publisher customers. We may be unable to maintain or add AdCenter for Publisher customers that generate a satisfactory volume of paid clicks at reasonable revenue-sharing rates, or at all. Our overall revenue is concentrated, with one

AdCenter for Publisher customer accounting for approximately 83% of our Publisher Solutions revenues and 8% of our overall revenues for the three months ended June 30, 2008. If we lose this AdCenter for Publisher customer, we would need to find alternative sources of revenue to replace the lost revenue share on paid clicks. Other publishers who become our customers may not be available at reasonable revenue share rates, they will likely be subject to competition from various other online advertising service providers, and they may have smaller audiences or viewers that respond less to online advertisements. If we are unable to maintain or generate new AdCenter for Publisher arrangements, then our ability to generate revenue may be seriously harmed.

We have generated significant losses in the past and we may be unable to achieve operating profitability in the foreseeable future, and if we achieve profitability, we may be unable to maintain it, which could result in a decline in our stock price

We had net income of approximately $0.1 million for the three months ended June 30, 2008 and as of June 30, 2008 our accumulated deficit was approximately $214.7 million. We may be unable to achieve and maintain profitability in the foreseeable future. Our ability to achieve and maintain profitability will depend on our ability to generate additional revenue and contain our expenses. In order to generate additional revenue, we will need to expand our network of distribution network partners, increase the amount our advertisers spend on our ad network, expand our advertiser base, offer our publisher products to additional publisher customers and experience an increase in paid clicks across our network and publisher products. We may be unable to accomplish some or any of these goals because of the risks identified in this report or for unforeseen reasons. Also, we may be unable to contain our costs due to the need to make revenue sharing payments to our distribution network partners, to invest in product development, and market our products. Because of the foregoing factors, and others outlined in this report, we may be unable to achieve profitability in the future, which could result in a decline in our stock price.

If we experience downward pressure on our revenue per click and/or match rate, or we are unable to rebuild our revenue per click and/or match rate, our financial results will suffer

We have experienced, and may in the future experience, downward pressure on our average revenue per click and average match rate, which is the rate at which paid listings are matched against search queries, due to various factors. We may experience decreases in revenue per click or average match rate in the future for many reasons, including the erosion of our advertiser base, the reduction in average advertiser spend, the reduction in the number of listings purchased by advertisers, changes in the composition of our distribution network or other reasons. If our revenue per click or average match rate falls for any reason, or if we are unable to grow our revenue per click and average match rate, then we may be unable to achieve our financial projections and our stock price would likely suffer.

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

Our growth depends on our ability to build an advertiser base that corresponds with the characteristics of our distribution network. Our distribution network, which currently consists of a diversified network of small distribution sources, may change as new distribution sources are added and old distribution sources are removed. Advertisers may view these changes to the distribution network negatively, and existing or potential advertisers may elect to purchase fewer or no listings advertisements for display on our distribution network. If this occurs, it is likely that our average revenue per click and average match rate may decline and our stock price would likely suffer.

Our growth depends upon our ability to offer and support our technology services to online publishers, and there are risks associated with introducing new products and services

To maintain and grow our revenue, part of our strategy is to offer and host syndicated technology services to online publishers. Our development, testing and implementation efforts for these products and services have required, and are expected to continue to require, substantial investments of our time. Also, we do not have significant experience offering services to online publishers, and we may not gain publisher acceptance of our offerings. We may be unable to successfully implement syndicated publisher solutions, or our implementation of a solution may interfere with our ability to operate our other products and services or other implementations, or a publisher customer may decide not to use or continue to use our solution or to increase their reliance on other online advertising service providers at the expense of our solution. These failures could have an adverse effect on our business and results of operations.

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

The online advertising industry is rapidly evolving and very turbulent, and we will need to continue developing new and upgraded products and services, adapt to new business environments and competition in order to maintain and grow revenue and reach our profitability goals. New advertising technologies could emerge that make our services comparatively less useful or new business methods could emerge that divert web traffic away from our Advertising Network and our AdCenter for Publishers’ ad networks. Competition from other web businesses may prevent us from attracting substantial traffic to our services. Also, we may inaccurately predict the direction of the online advertising market, which could lead us to make investments in technologies and products that do not generate sufficient returns. We may face platform and resource constraints that prevent us from developing

upgraded products and services. We may fail to successfully identify new products or services, or fail to bring new products or services to market in a timely and efficient manner. Rapid industry change makes it difficult for us to accurately anticipate customer needs for our products, particularly over longer periods.

We face intense competitive pressures, which could materially and adversely affect our financial results

We compete in the relatively new and rapidly evolving online advertising industry, which presents many uncertainties that could require us to further refine our business model. We compete with companies that provide paid placement products, paid inclusion products, and other forms of search marketing as well as contextually-targeted ad products and other types of online advertisements. We compete for advertisers on the basis of the quality and composition of our ad network, the price per click charged to advertisers, the volume of clicks that we can deliver to advertisers, tracking and reporting of campaign results, customer service and other factors. We also compete for distribution network partners and for ad placement on those partners’ sites on the basis of the relevance of our ads and the price per click charged to advertisers. We also experience competition for offering our publisher products to website publishers. Some of our competitors have larger distribution networks and proprietary traffic bases, longer operating histories, greater brand recognition higher revenues per click, better relevance and conversion rates, or better products and services than we have.

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

From time to time we evaluate corporate development opportunities, and when appropriate, we intend to make acquisitions of or significant investments in, complementary companies or technologies to increase our technological capabilities expand our service offerings, and extend the operating scale of our businesses. Acquisitions may divert the attention of management from the day-to-day operations of LookSmart. It may be difficult to retain key management and technical personnel of the acquired company during the transition period following an acquisition. Acquisitions or other strategic transactions may also result in dilution to our existing stockholders if we issue additional equity securities and may increase our debt. We may also be required to amortize significant amounts of intangible assets, record impairment of goodwill in connection with future or past acquisitions, or divest non-performing assets at below-market prices, which would adversely affect our operating results.

We have acquired businesses and technologies in recent years, including the acquisition of Net Nanny from BioNet Systems, LLC in the second quarter of 2004, (which was sold in January of 2007) and Furl, LLC in the third quarter of 2004. Integration of acquired companies and technologies into LookSmart is likely to be expensive, time-consuming and strain our managerial resources. We may not be successful in integrating any acquired businesses or technologies and these transactions may not achieve anticipated business benefits.

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

Our success depends on our ability to identify, attract, retain and motivate highly skilled development, technical, sales, and management personnel. We have a limited number of key development, technical, sales and management personnel performing critical company functions, and the loss of the services of any of our key employees, particularly any of our executive team members or key technical personnel, could adversely affect our business. The combination of depressed capital markets, stock volatility and small market capitalization may not allow us to offer competitive equity based compensation to attract and retain key personnel. Also, our September 2007 restructuring has placed additional burdens on all remaining personnel, including our remaining Finance staff. In recent years, we have experienced significant turnover in our management team. For example, both our Chief Executive Officer and Chief Technical Officer resigned in August 2007 and in June 2007 our Chief Financial and Operating Officer announced his resignation as of November 2007. The employment of a new Chief Financial Officer in December 2007 ended in January 2008. Our Chief Executive Officer joined us in that role in August 2007 and our two General Managers, who have responsibility for our Ad Network and Publisher Solutions, joined us in April 2007. Other members of management have also joined us in the last year, and the management team as a whole has had only a limited time to work together. We cannot assure you that we will be able to retain our key employees or that we can identify attract and retain highly skilled personnel in the future.

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

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

•

customization of our matching algorithms and ad serving technologies,

•

substantial increases in the number of queries to our database,

•

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

•

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

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

Risks Related to Operating in our Industry

Seasonal fluctuations in internet usage and traditional retail seasonality have affected, and are likely to continue to affect, our business

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

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

Invalid clicks, most often due to “click fraud”, are an ongoing problem for the Internet search advertising industry, and we are exposed to the risk of invalid clicks on our paid listings. Invalid clicks occur when a person or robotic software causes a click on a paid listing to occur for some reason other than to view the underlying content. We invest significant time and resources in preventing, detecting and eliminating invalid traffic from our distribution network. However, the perpetrators of click fraud have developed sophisticated methods to evade detection, and we are unlikely to detect and remove all invalid traffic from our search network. We are subject to advertiser complaints and litigation regarding invalid clicks, and we may be subject to advertiser complaints, claims, litigation or inquiries in the future. For example, in March 2005 the Company was served with the second amended complaint in a class action lawsuit (Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc.) alleging that the Company engaged in click fraud and seeking damages as a result. We have from time to time credited invoices or refunded revenue to our customers due to suspicious traffic, and we expect to continue to do so in the future. If our systems to detect invalid traffic are insufficient, or if we find new evidence of past invalid clicks, we may have to issue credits or refunds retroactively to our advertisers, and we may still have to pay revenue share to our distribution network partners. This could negatively affect our profitability and hurt our brand. If traffic consisting of invalid clicks is not detected and removed from our advertising network, the affected advertisers may experience a reduced return on their investment in our online advertising because the invalid clicks will not lead to actual sales for the advertisers. This could lead the advertisers to become dissatisfied with our products, which could lead to loss of advertisers and revenue and could materially and adversely affect our financial results.

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

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

The occurrence of a natural disaster or unanticipated problems at our principal headquarters or at a third-party facility could cause interruptions or delays in our business, loss of data or could render us unable to provide some services. Our California facilities exist on or near known earthquake fault zones and a significant earthquake could cause an interruption in our services. We do not have back-up sites for our main customer operations center, which is located at our San Francisco, California office. An interruption in our ability to serve advertisements, track paid clicks, bill and collect invoices, and provide customer support would materially and adversely affect our financial results.

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

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

We have an agreement with Savvis Communications, Inc. to house equipment for web serving and networking and to provide network connectivity services. We also have agreements with third-party click tracking and ad-serving technology providers. We also have an agreement with AboveNet Communications, Inc. to provide network connectivity services. We do not presently maintain fully redundant click tracking, customer account and web serving systems at separate locations. Accordingly, our operations depend on Savvis and AboveNet to protect the systems in their data centers from system failures, earthquake, fire, power loss, water damage, telecommunications failure, hackers, vandalism and similar events. Neither Savvis nor AboveNet guarantees that our Internet access will be uninterrupted, error-free or secure. We have developed a 30-day disaster recovery plan to respond in the event of a catastrophic loss of our critical, revenue-generating systems. We have an agreement with Raging Wire, Inc. in Sacramento, California to provide co-location and networking services for our critical systems in such an event. Although we maintain property insurance and business interruption insurance, such insurance may not protect against some risks and we cannot guarantee that our insurance will be adequate to compensate us for all losses that may occur as a result of a catastrophic system failure. Also, if our third-party click tracking or ad-serving technology providers experience service interruptions, errors or security breaches, our ability to track, realize and record revenue would suffer.

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

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

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

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

Internet, technology, media companies and patent holding companies often possess a significant number of patents. Further, many of these companies and other parties are actively developing online advertising, search, indexing, electronic commerce and other Web-related technologies, as well as a variety of online business models and methods. We believe that these parties will continue to take steps to protect these technologies, including, but not limited to, seeking patent protection. As a result, we may face claims of infringement of patents and other intellectual property rights held by others. Also, as we expand our business, acquire and maintain our customer base, and develop new technologies, products and services, we may become increasingly subject to intellectual property infringement claims. In the event that there is a claim or determination that we infringe third-party proprietary rights such as patents, copyrights, trademark rights, trade secret rights or other third party rights such as publicity and privacy rights, we could incur substantial monetary liability, be required to enter into costly royalty or licensing agreements or be prevented from using the rights, which could require us to change our business practices in the future and limit our ability to compete effectively. We may also incur substantial expenses in defending against third-party infringement claims regardless of the merit of such claims. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain third-party intellectual property infringement claims or determinations, which could increase our costs in defending such claims and our damages. For example, in November of 2007, we received a request for indemnification from one publisher customer relating to a patent infringement suit filed against it. The occurrence of any of these results could harm our brand and negatively impact our operating results.

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

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

the labeling, delivery or content of our advertisements, or if we are subject to legal proceedings regarding these issues, it may reduce the desirability of our services or the types of advertisements that we can run, and our business could be materially and adversely harmed. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain claims related to online advertising laws, regulations and enforcement actions, which could increase our costs in defending such claims and our damages.

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

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

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

Our advertisers and partners may place information, known as cookies, on a user’s hard drive, generally without the user’s knowledge or consent. This technology enables web site operators to target specific consumers with a particular advertisement, to limit the number of times a user is shown a particular advertisement, and to track certain behavioral data.

Although some Internet browsers allow consumers to modify their browser settings to remove cookies at any time or to prevent cookies from being stored on their hard drives, many consumers are not aware of this option or are not knowledgeable enough to use this option. Some privacy advocates and governmental bodies have suggested limiting or eliminating the use of cookies. If this technology is reduced or limited, the Internet may become less attractive to advertisers and sponsors, which could result in a decline in our revenue.

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

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

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

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

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

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

Our ability to retain existing credit facilities or obtain new credit facilities may adversely affect the way we conduct our business

In March 2008 our capital lease line expired. In April 2008 we renewed our capital lease line, which will expire on December 30, 2008. We may need to renew this lease line or we may need to enter into additional credit facilities to operate the business. There is no guarantee that we will be successful in securing a new credit facility or renewing the existing line of credit due to the current market conditions.

Risks Related to Accounting Matters

Accounting for employee stock options using the fair value method could significantly reduce (increase) our net income (loss)

We adopted Statement of Financial Accounting Standards No. 123R, Share-Based Payment (“SFAS 123R”) starting January 1, 2006. Under SFAS 123R, we are required to account for the fair value of stock options granted to employees as compensation expense, which is likely to have a significant adverse impact on our GAAP results of operations and net income (loss) per share. If we reduce or alter our use of share-based compensation to minimize the recognition of these expenses, our ability to recruit, motivate and retain employees may be impaired, which could put us at a competitive disadvantage in the marketplace. In order to prevent any net decrease in their overall compensation packages, we might decide to make corresponding increases in the cash compensation we pay to current and prospective new employees.

An increase in employee wages and salaries would diminish our cash available for marketing, product development and other uses and might adversely impact our GAAP results of operations.

Risks Related to the Capital Market

Our quarterly revenues and operating results may fluctuate for many reasons, each of which may negatively affect our stock price

Our revenues and operating results will likely fluctuate significantly from quarter to quarter as a result of a variety of factors, including without limitation:

•

change in the composition of our Advertiser Network customer base,

•

change in composition of our AdCenter for Publishers customer base,

•

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

•

changes in the number of advertisers who purchase our listings, or the amount of spending per customer,

•

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

•

change in our traffic acquisition costs (TAC) related to our Advertiser Network,

•

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

•

the effect of SFAS 123R, which became effective January 1, 2006, and requires that we account for the fair value of stock awards granted to employees as compensation expense.

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

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

The stock market has experienced significant price and volume fluctuations in recent years, and the stock prices of Internet companies have been extremely volatile. The low trading volume of our common stock may adversely affect its liquidity and reduce the number of market makers and/or large investors willing to trade in our common stock, making wider fluctuations in the quoted price of our common stock more likely to occur. Also, because we have made significant changes as a result of the expiration of our contractual relationship with Microsoft’s MSN in the first quarter of 2004, it is extremely difficult to evaluate our business and prospects. You should evaluate our business in light of the risks, uncertainties, expenses, delays and difficulties associated with managing and growing a relatively new business, many of which are beyond our control.

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

•

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

•

quarterly fluctuations in our operating results,

•

the termination or expiration of our distribution agreements,

•

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

•

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

•

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

•

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

•

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

•

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

•

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

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

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

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

•

fund the additional operations and capital expenditures,

•

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

•

develop and upgrade our technology infrastructure beyond current plans,

•

develop new product and service offerings,

•

take advantage of favorable conditions in capital markets, or

•

respond to competitive pressures.

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

A significant market downturn may lead to a decline in the value of securities we hold in our investment portfolio

During the second half of 2007, the global markets for fixed-income securities, particularly the markets for financial instruments collateralized by sub-prime mortgages, experienced significant disruption. This disruption affected the liquidity and pricing of securities traded in these markets, as well as the returns of, and levels of redemptions in, investment vehicles investing in those instruments. This downturn may adversely affect the value and liquidity of securities we hold in our investment portfolio.

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

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

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

On June 16, 2008, we held our annual stockholder meeting. At the meeting, a quorum of our stockholders considered a proposal to re-elect Edward F. West and Timothy J. Wright to the Board of Directors. The following votes were cast by stockholders (in whole shares):


Director	For	Withheld	Abstain
Edward F. West	11,327,896	1,041,621	N/A
Timothy J. Wright	11,050,506	1,319,011	N/A

Directors Jean-Yves Dexmier, Mark Sanders, Teresa Dial and Anthony Castagna continued their terms thereafter.

At the same meeting, the stockholders also considered a proposal to ratify the Company’s Preferred Shares Rights Agreement (the “Rights Agreement”). The following votes were cast by stockholders (in whole shares):


For	Against	Abstain
1,677,076	5,067,978	5,682

Subsequently, on July 9, 2008 the Board determined that the Rights Agreement was no longer in the best interests of stockholders and terminated the Rights Agreement.

At the same meeting, the stockholders also considered a proposal to ratify the Board’s selection of Moss Adams LLP as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2008. The following votes were cast by stockholders (in whole shares):


For	Against	Abstain
12,321,430	35,137	12,950

At the same meeting, the stockholders also considered a proposal to transact any other business that may properly come before the annual meeting and any adjournment or postponement thereof. The following votes were cast by stockholders (in whole shares):


For	Against	Abstain
6,812,965	5,552,733	33,819

ITEM 6.

EXHIBITS

Please see the exhibit index following the signature page of this report.

SIGNATURE

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


LOOKSMART, LTD. Dated: August 11, 2008

By:		/s/ R. BRIAN GIBSON
		R. Brian Gibson, Principal Accounting Officer and Acting Chief Financial Officer (Principal Financial Officer)

EXHIBIT INDEX


Exhibit Number		Description of Document
3.1		Restated Certificate of Incorporation (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on November 14, 2005).

3.2		Bylaws (Filed with the Company’s Quarterly Report on Form 10-Q 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 filed with the SEC on November 14, 2005).

4.2		Forms of Stock Option Agreement used by the Registrant in connection with grants of stock options to employees, directors and other service providers in connection with the Amended and Restated 1998 Stock Plan (Filed with the Company’s Current Report on Form 8-K filed with the SEC on October 22, 2004).

4.3		Form of cover sheet for use with Stock Option Agreement for grants of stock options to executives in connection with the Company’s Executive Team Incentive Plan, Plan Year 2006 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006).

4.4		Form of Indemnification Agreement entered into between the Registrant and each of its directors and officers (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999).

4.5		Form of cover sheet for use with stock option agreement for grants of stock options to executives in connection with the Company’s Executive Team Incentive Plan, Plan Year 2007 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on March 2, 2007).

10.1		Form of Indemnification Agreement entered into between the Registrant and each of its directors and officers (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999).

10.2		Amended and Restated 1998 Stock Plan (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999).

10.3		1999 Employee Stock Purchase Plan as amended (Filed with the Company’s Registration Statement on Form S-8 (File No. 333-129987) filed with the SEC on November 29, 2005).

10.4		LookSmart, Ltd. Executive Team Incentive Plan, Plan Year 2006 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006).

10.5		LookSmart, Ltd. Executive Team Incentive Plan, Plan Year 2007 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on March 2, 2007).

10.6		LookSmart, Ltd. 2008 Executive Team Incentive Plan (Filed with the Company’s Current Report on Form 8-K filed with the SEC on February 19, 2008).

10.7		Zeal Media, Inc. 1999 Stock Plan (Filed with the Company’s Registration Statement on Form S-8 filed with the SEC on December 7, 2000).

10.8		WiseNut, Inc. 1999 Stock Incentive Plan (Filed with the Company’s Registration Statement on Form S-8 filed with the SEC on April 18, 2002).

10.9		LookSmart 2007 Equity Incentive Plan (Filed with the Company’s Definitive Proxy Statement and Amended Definitive Proxy Statement with the SEC on April 30 and June 11, 2007, respectively).

10.12		Lease Agreement with Rosenberg SOMA Investments III, LLC for property located at 625 Second Street, San Francisco, California, dated May 5, 1999 (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999).

10.13		LookSmart, Ltd. Form Change of Control/Severance Agreement (Filed with The Company’s Quarterly report on Form 10-Q filed with the SEC on November 9, 2007).

10.14		Employment Offer Letter between the Company and its Chief Financial Officer dated November 15, 2007 (Filed with the Company’s Current Report on Form 8-K/A filed with the SEC on December 27, 2007).

10.15		Preferred Shares Rights Agreement dated November 15, 2007 between the Company and Mellon Investor Services LLC (Filed with the Company’s Current Report on Form 8-K with the SEC on November 21, 2007).

10.16		Asset Purchase Agreement between the Company and CNET Networks, Inc. dated November 5, 2007 (Filed with the Company’s Current Report on Form 8-K with the SEC on November 7, 2007).


Exhibit Number		Description of Document
10.17		Amendment to LookSmart Preferred Shares Rights Agreement dated July 8, 2008 (Filed with the Company’s Current Report on Form 8-K with the SEC on July 8, 2008).

10.31		Fourth Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and IAC Search & Media dated June 14, 2007 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).

10.32		Sponsored Links Master Terms and Conditions between the Registrant and eBay, Inc. dated March 12, 2007 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).

10.33‡		LookSmart Reseller Terms and Conditions with MeziMedia dated September 7, 2005. (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2007).

10.34		Co-Location Services Agreement between the Registrant and Savvis Communications Corporation dated March 29, 2008 (Filed with the Company’s Quarterly Report on Form 10-Q with the SEC on May 12, 2008).

10.35+		Second Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and IAC Search & Media dated May 16, 2006 (Filed with the Company’s Form 10-Q with the SEC on August 8, 2006).

10.36‡		Third Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and IAC Search & Media dated January 1, 2007. (Filed with the Company’s Annual Report on Form 10-K on March 16, 2007).

10.37+		AdCenter License, Hosting and Support Agreement between the Registrant and Ask Jeeves, Inc. dated May 16, 2005 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006).

10.38+		Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and Ask Jeeves, Inc. dated January 20, 2006 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006).

10.39+		Paid Listings License Agreement between the Registrant and SearchFeed.com dated April 15, 2006 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006).

10.40+		License Agreement between the Registrant and SearchFeed.com dated November 23, 2003, as Amended on March 29, 2004 and March 21, 2005 (Filed with the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2006).

10.41		Promotion letter between the Company and its Vice-President, Technology dated September 7, 2007 (Filed with the Company’s Current Report on Form 8-K with the SEC on September 12, 2007).

10.42		Amendment to employment offer between the Company and its Chief Financial Officer dated August 27, 2007 (Filed with the Company’s Current Report on Form 8-K with the SEC on September 4, 2007).

10.43		Employment offer letter between the Registrant and its Vice President, East Coast dated March 22, 2007 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2007).

10.44		Employment offer letter between the Registrant and its Vice President, Publisher Sales dated March 23, 2007 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2007).

10.45		Promotion letter between the Registrant and its Vice President, Finance and Principal Accounting Officer dated July 10, 2007. (Filed with the Company’s Current Report on Form 8-K filed with the SEC on July 16, 2007).

10.46		Severance Agreement and General Release between the Company and Dave Hills dated August 2, 2007 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on August 7, 2007).

10.47+		Paid Listings License Agreement between the Registrant and Kontera Technologies, Inc. dated July 17, 2006. (Filed with the Company’s Quarterly Report on Form 10-Q with the SEC on November 9, 2007).


Exhibit Number		Description of Document
10.48+		License Agreement between the Registrant and Oversee.net dated April 1, 2004 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on November 9, 2007).

10.49		Letter from Oversee.net to the Registrant dated January 21, 2008 terminating Agreement between Registrant and Oversee.net dated April 1, 2004 effective June 30, 2008 (Filed with the Company’s Annual Report on Form 10-K filed with the SEC on March 17, 2008).

10.50+		Backfill Agreement between the Registrant and Internext Media Corp. dated February 8, 2008 (Filed with the Company’s Quarterly Report on Form 10-Q on May 12, 2008).

10.58		Amendment to employment offer letter between the Registrant and its Chief Executive Officer dated June 21, 2005 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on June 21, 2005).

10.59		Employment offer letter between the Registrant and its General Counsel and Senior Vice President dated as of July 11, 2005 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on July 14, 2005).

10.63		Promotion letter between the Registrant and its Vice-President, Advertising Sales dated November 15, 2006 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on November 21, 2006).

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

(*)	Filed herewith

(‡)	Material in the exhibit marked with a “‡” has been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission. Omitted portions have been filed separately with the Securities and Exchange Commission.

(+)	Confidential treatment has been granted with respect to portions of the exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.