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 maintain or grow our listings advertiser base, 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 a search advertising network solutions company that provides relevant solutions for search advertisers and publishers. LookSmart was organized in 1996 and is incorporated in the State of Delaware.

LookSmart offers search advertisers targeted, pay-per-click (PPC) search, and contextual search advertising via a monitored search advertising distribution network ("AdCenter"). The Company's extensive search advertising distribution network includes publishers and search partners within certain vertical market segments in the United States and certain other countries. 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 search advertising campaigns. The advertiser network service offering provided 90% and 88% of total revenues in the quarters ended September 30, 2008, and 2007, respectively.

LookSmart also offers publishers licensed private-label search advertiser network solutions based on its AdCenter platform technology ("Publisher Solutions"). Publisher Solutions consist of hosted auction-based ad serving with an ad backfill capability that allows search engines, networks, media companies, social networking sites, retail sites, directories, ISPs and portals to manage their advertiser relationships, distribution channels and accounts. The publisher solutions service offering has provided 10%, and 12% of total revenues in the quarters ended September 30, 2008, and 2007, respectively.

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 and trademark 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 Statement of

Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144") as "assets held for sale." 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 included in this filing. See Notes 3, 5 and 6 for further details. At September 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.

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.

Investments

We account for investments in securities under SFAS 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"). SFAS 115 requires the classification of investments in debt and equity securities with readily determinable fair values as "held-to-maturity," "available-for-sale," or "trading."

We invest our excess cash primarily in debt instruments of high-quality corporate and government issuers. All highly liquid instruments with maturities at the date of purchase greater than ninety days are considered investments. All instruments with maturities greater than one year from the balance sheet date are considered long-term investments unless management intends to liquidate such securities in the current operating cycle. Such securities are classified as short-term investments. These securities are classified as available-for-sale and carried at fair value in accordance with SFAS 157, Fair Value Measures ("SFAS 157").

Changes in value of these investments are primarily related to changes in interest rates and are considered to be temporary in nature. Except for declines in fair value that are not considered temporary, net unrealized gains or losses on these investments are reported as a component of accumulated comprehensive income (loss) in stockholders' equity. We recognize realized gains and losses upon sale of investments using the specific identification method.

Revenue Recognition

Our online search advertising revenue is primarily composed of per-click fees that we charge customers. The per-click fee charged for keyword-targeted listings is calculated based on the results of online bidding for keywords or page content, up to a maximum cost per keyword or page content set by the customer. Revenue also includes revenue share from licensing of private-labeled versions of our 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 licenses to the AdCenter. These license arrangements include multiple elements: revenue-sharing based on the publishers' customer's monthly revenue generated through the AdCenter application; upfront fees; and other 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, other license fees over the term of the license, and revenue-sharing portions over the period in which such revenue is earned. In all cases, revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectability of the resulting receivable is reasonably assured.

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

Determining collectability of accounts receivable 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 customers failing to make required payments. This valuation allowance is reviewed on a periodic basis to determine whether a provision or reversal is required. The review is based on factors including the application of historical collection rates to current receivables. 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 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 development costs 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, net

We have recorded a restructuring accrual related to closing certain leased facilities in accordance with SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. 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

We account for share-based compensation costs in accordance with 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 Nine Months Ended September 30, 2008

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



                                                        Three Months Ended         Nine Months Ended
                                                          September 30,              September 30,
                                                       2008           2007         2008          2007
Revenue                                                 100.0 %        100.0 %      100.0 %      100.0 %
Cost of revenue                                          59.9 %         55.8 %       59.4 %       55.5 %

Gross profit                                             40.1 %         44.2 %       40.6 %       44.5 %
Operating expenses:
Sales and marketing                                      16.0 %         16.7 %       13.3 %       17.0 %
Product development                                      18.5 %         27.2 %       17.2 %       24.8 %
General and administrative                               16.9 %         28.3 %       15.6 %       24.8 %
Restructuring costs                                       1.4 %          2.0 %        0.2 %        0.6 %

Total operating expenses                                 52.8 %         74.2 %       46.3 %       67.2 %
Loss from operations                                    (12.7 %)       (30.0 %)      (5.7 %)     (22.7 %)
Non-operating income, net                                 1.5 %          4.3 %        1.8 %        4.1 %

Loss from continuing operations before income taxes     (11.2 %)       (25.7 %)      (3.9 %)     (18.6 %)
Income tax expense (credit)                               0.0 %          0.0 %        0.0 %        0.0 %

Loss from continuing operations                         (11.2 %)       (25.7 %)      (3.9 %)     (18.6 %)
Loss from discontinued operations, net of tax             0.0 %        (12.6 %)      (0.9 %)      (8.1 %)

Net loss                                                (11.2 %)       (38.3 %)      (4.8 %)     (26.7 %)

Revenues

Revenues are derived from the Company's two service offerings or "products":
Advertiser Networks and Publisher Solutions.

The Company recognized approximately $15.4 and $50.0 million of total revenue during the three and nine months ended September 30, 2008, respectively, up 37% and 36%, respectively, from the approximate $11.3 million and $36.7 million recognized during the three and nine months ended September 30, 2007, respectively. The approximate $4.1 million and $13.3 million increases in total revenue for the three and nine months ending September 30, 2008 as compared to the comparable periods of 2007 was primarily driven by increasing paid clicks.

For the three and nine months ended September 30, 2008, IAC Search and Media ("IAC") represented approximately $1.4 million and $4.0 million, or 92% and 87%, respectively, of the Publisher Solutions revenue. Our contract with IAC expires December 31, 2009. IAC is currently soliciting bids for a new contract.

In August 2007, the Company's management made the decision to exit certain consumer products activities and to sell or otherwise dispose of various related websites and assets associated those activities. In March 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. In 2008, the results of operations to be disposed of and previously disposed assets, including related gains (losses), have been classified as discontinued operations.

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

                                               Three Months Ended                  Nine Months Ended
                                                 September 30,                       September 30,
                                                2008         2007     Change        2008        2007     Change
Online advertising revenues:
Advertiser Networks                          $    13,901   $  9,968       39 %   $   45,441   $ 32,805       39 %
Publisher Solutions                                1,522      1,319       15 %        4,618      3,898       18 %

Total revenues                               $    15,423   $ 11,287       37 %   $   50,059   $ 36,703       36 %

We recognized approximately $13.9 million and $45.4 million of Advertiser Networks revenue during the three and nine months ended September 30, 2008, respectively; both up 39% from the approximate $10.0 million and $32.8 million recognized during the three and nine months ended September 30, 2007, respectively. Revenues from Advertiser Networks increased in the third quarter of 2008 by approximately $3.9 million and in the first nine months of 2008 by approximately $12.6 million compared to the same periods in 2007 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 our platform, performance optimization and better match rate. Total paid clicks totaled approximately 184 million for the third quarter of 2008, as compared to approximately 83 million for the third quarter of 2007, an increase of 122%, with average RPC decreasing to $0.08 from $0.12. Total paid clicks totaled approximately 531 million for the nine months ended September 30, 2008, as compared to approximately 297 million for the comparable period of 2007, an increase of 79%, with average RPC decreasing to $0.09 from $0.11. The decreased 2008 PRC as compared to 2007 is primarily a result of shifts in the mix of direct and intermediary sales channels.

We recognized approximately $1.5 million of Publisher Solutions revenue during the three months ended September 30, 2008, a 15% increase from the approximate $1.3 million recognized during the three months ended September 30, 2007. During the nine months ended September 30, 2008, we recognized approximately $4.6 million of Publisher Solutions revenue during the nine months ended September 30, 2008, up 18%, or approximately $0.7 million, from the approximate $3.9 million recognized in the same period of the prior year. Publisher Solutions revenue increases for the three and nine months ended September 30, 2008 as compared to the same periods in 2007 are attributed to increases by one significant publisher customer partially offset by reduced revenue from other publishers.

Revenue amounts reflect the reclassification of insignificant amounts in 2008, and approximately $1.3 million and $3.8 million of revenue of various related websites and assets associated with the consumer products activities to discontinued operations for the three and nine months ended September 30, 2007, respectively. See Note 3 to the Unaudited Condensed Consolidated Financial Statements for further details.

Cost of Revenues and Gross Margin

Cost of revenues, consisting of traffic acquisition costs ("TAC"), costs paid to
our distribution network partners, connectivity costs, hosting expenses,
commissions paid to advertising agencies, and credit card fees were as follows
(in thousands):



                                            Three Months Ended                     Nine Months Ended
                                               September 30,                         September 30,
                                             2008          2007       Change       2008          2007       Change
Traffic acquisition costs                 $    8,688      $ 5,873         48 %   $  28,143     $ 19,266         46 %
Other costs                                      551          425         30 %       1,572        1,105         42 %

Total cost of revenues                    $    9,239      $ 6,298         47 %   $  29,715     $ 20,371         46 %

Total cost of revenues as percentage of
total revenue                                   59.9 %       55.8 %                   59.4 %       55.5 %
Traffic acquisition costs as percentage
of online advertising revenue                   62.5 %       58.9 %                   61.9 %       58.7 %

Our total cost of revenue during the three months ended September 30, 2008 was approximately $9.2 million, up approximately $2.9 million, or 47% from the approximate $6.3 million in the three months ended September 30, 2007. Total cost of revenue for the nine months ended September 30, 2008 was approximately . . .