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 and/or distribution network, that existing and potential distribution partners may opt to work with, or favor the products of, competitors if our competitors offer more favorable products or pricing terms, that we may be unable to grow our online search advertising revenue and/or find alternative sources of revenue, that we may be unable to attain or maintain customer acceptance of our publisher solutions products, that changes in the distribution network composition may lead to decreases in query volumes, that we may be unable to maintain or improve our query volume, match rate, number of paid clicks, average revenue per click, conversion rate or other ad network metrics, that we may be unable to achieve or maintain profitability, that we may be unable to retain our existing credit facilities or obtain new credit facilities, that we may be unable to attract and retain key personnel, that we may have unexpected increases in costs and expenses, 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 (referred to as the "AdCenter" platform). 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 91% and 92% of total revenues in the quarters ended June 30, 2009 and 2008, respectively, and 91% of total revenues for the six months ended June 30, 2009 and 2008.

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, Internet Service Providers ("ISPs") and portals to manage their advertiser relationships, distribution channels and accounts. The publisher solutions service offering has provided 9%, and 8% of total revenues in the quarters ended June 30, 2009 and 2008, respectively, and 9% of total revenues for each of the six months ended June 30, 2009 and 2008.

In 2007, our management made the decision to exit certain consumer products activities and to sell or otherwise dispose of the various consumer related websites and assets associated with those activities. In the first quarter of 2008, our management made the decision to exit its remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. During 2008, we sold the intellectual property rights to the "Wisenut" trademark and related domain names and decided to wind down the Furl operations. In the first quarter of 2009, the Furl assets were sold for an insignificant amount. 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 Note 3). At June 30, 2009, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology and other assets.

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 Statement of Financial Accounting Standards ("SFAS") No. 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 No. 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 other comprehensive income (loss) in stockholders' equity. We recognize realized gains and losses upon sale of investments using the specific identification method.

Fair Value Measurements

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.

Our estimates of fair value for assets and liabilities are based on the framework established in SFAS 157. The framework is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates in the SFAS 157 hierarchy is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions. The three levels of the hierarchy are as follows:

Level 1: Unadjusted quoted market prices for identical assets or liabilities in active markets that we have the ability to access.

Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, default rates, etc.) or can be corroborated by observable market data.

Level 3: Valuations based on models where significant inputs are not observable. The unobservable inputs reflect our assumptions about the assumptions that market participants would use.

Revenue Recognition

Our online search advertising revenue is primarily composed of per-click fees that we charge customers. The per-click fee charged for keyword-targeted listings is calculated based on the results of online bidding for keywords or page content, up to a maximum cost per keyword or page content set by the customer. Revenue also includes revenue share from licensing of private-labeled versions of our 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 ("EITF") Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, 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 publisher's 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 ("SAB") No. 104, Revenue Recognition in Financial Statements, and EITF No. 00-21, Revenue Arrangements with Multiple Deliverables. We recognize upfront fees over the term of the arrangement or the expected period of performance, other license fees over the term of the license, and revenue-sharing portions over the period in which such revenue is earned. In all cases, revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectability of the resulting receivable is reasonably assured.

We provide a provision against revenue for estimated reductions resulting from billing adjustments and customer refunds. The amounts of these provisions are evaluated periodically based upon customer experience and historical trends.

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

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 an additional provision or reversal is required. The review is based on factors including the application of historical collection rates to current receivables and whether economic conditions are more or less favorable than we anticipated. 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

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142"), goodwill and other intangibles with indefinite useful lives are not amortized but tested for impairment annually or more frequently when events or circumstances indicates that the carrying value of a reporting unit more likely than not exceeds its fair value. Our annual goodwill impairment testing date is December 31 of each year. In addition, we periodically re-assess the valuation and asset lives of intangible assets with definite lives to conform to changes in management's estimates of future performance.

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. As of June 30, 2009 and December 31, 2008, we have no recorded goodwill. The majority of intangible assets are amortized over two to seven years, the period of expected benefit.

SFAS 142 also requires that intangible assets with definite lives be amortized over their estimated useful life and reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"). We amortize acquired intangible assets with definite lives over periods from two to seven years and the amortization expense is primarily classified as cost of revenue in our Unaudited Condensed Consolidated Statements of Operations.

Impairment of Long-Lived Assets

In accordance with the provisions of SFAS 144, we review long-lived assets held or used in operations, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. SFAS 144 requires the subject assets to be tested for impairment at the lowest level of operations that generates cash flows that are largely independent of the cash flows from those of other groups of asset and liabilities. We have determined that the equity of our single reporting unit to be the lowest level of operation at which independent cash flows could be identified. Under SFAS 144, an impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Impairment, if any, is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. Assets to be disposed of are reported at the lower of carrying amount or fair value less cost to dispose.

As of June 30, 2009, purchased technology of $0.3 million was impaired by approximately $0.2 million because an associated initiative was discontinued. Any adjustment to the estimated impairment based on additional information providing a more accurate measurement will be recognized in subsequent reporting periods.

The Company tested its long-lived assets used in operations for impairment as of December 31, 2008 and determined they were not impaired.

Deferred Taxes

We account for income taxes using the liability method in accordance with SFAS No. 109, Accounting for Income Taxes. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. Due to our history of losses and the uncertainty of net operating loss utilization, we have established a valuation allowance for the full amount of our deferred tax assets. We adopted Financial Accounting Standards Board ("FASB") Interpretation ("FIN") No. 48 Accounting for Uncertainty for Income Taxes-an interpretation of FASB Statement No. 109 ("FIN 48") effective January 1, 2007. In accordance with the provisions of FIN 48, we record liabilities, where appropriate, for all uncertain income tax positions. We recognize potential accrued interest and penalties related to unrecognized tax benefits within operations as income tax expense.

Internal Use Software Development Costs

We account for internal use software in accordance with American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 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 developing internal-use computer software.

Management exercises judgment in determining when costs related to a project may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the amortization period for the capitalized costs. 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 restructuring accruals related to closing of certain leased facilities, as well as severance costs related to workforce reductions in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal of Activities. Management's judgment is required when 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 No. 123R, Share-Based Payment ("SFAS 123R"), which revised SFAS No. 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 requires the recognition of the fair value of stock compensation in net income (loss).

We use the Black-Scholes method of valuation for share-based awards granted. We elected to adopt the alternative transition method provided in FASB Staff Position No. FAS 123R-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards, for calculating the tax effects of share-based compensation to establish the beginning balance of the additional paid-in capital pool ("APIC pool") related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS 123R.

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, 2009

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          Six Months Ended
                                                        June 30,                   June 30,
                                                   2009           2008         2009         2008
Revenue                                             100.0 %       100.0 %      100.0 %      100.0 %
Cost of revenue                                      60.4 %        60.4 %       60.8 %       59.1 %

Gross profit                                         39.6 %        39.6 %       39.2 %       40.9 %
Operating expenses:
Sales and marketing                                  11.1 %        11.7 %       10.7 %       12.2 %
Product development                                  18.9 %        16.6 %       19.3 %       16.6 %
General and administrative                           17.4 %        13.8 %       21.4 %       15.1 %
Restructuring charge (benefit)                        1.7 %        (0.8 )%       0.9 %       (0.4 )%
Impairment charge                                     1.4 %         0.0 %        0.7 %        0.0 %

Total operating expenses                             50.5 %        41.3 %       53.0 %       43.5 %

Loss from operations                                (10.9 )%       (1.7 )%     (13.8 )%      (2.6 )%
Non-operating income, net                             0.2 %         1.5 %        0.3 %        2.0 %

Loss from continuing operations before income
taxes                                               (10.7 )%       (0.2 )%     (13.5 )%      (0.6 )%
Income tax expense                                    0.0 %         0.0 %        0.0 %        0.0 %

Loss from continuing operations                     (10.7 )%       (0.2 )%     (13.5 )%      (0.6 )%
Income (loss) from discontinued operations, net
of tax                                                1.0 %        (0.8 )%       0.9 %       (1.3 )%

Net loss                                             (9.7 )%       (1.0 )%     (12.6 )%      (1.9 )%

Revenues

Revenue is derived from the Company's two service offerings or "products":
Advertiser Networks and Publisher Solutions. Total revenue and revenue from
Advertiser Networks and Publisher Solutions for each of the three and six months
ended June 30, 2009 and 2008 were as follows (in thousands):



                                            Three Months Ended June 30,
                                   % of                    % of         Dollar
                         2009     Revenue        2008     Revenue       Change       % Change
 Advertiser Networks   $ 12,011        91 %    $ 15,738        92 %    $ (3,727 )         (24 )%
 Publisher Solutions      1,212         9 %       1,354         8 %        (142 )         (10 )%

 Total revenue         $ 13,223       100 %    $ 17,092       100 %    $ (3,869 )         (23 )%


                                             Six Months Ended June 30,
                                   % of                    % of         Dollar
                         2009     Revenue        2008     Revenue       Change       % Change
 Advertiser Networks   $ 24,026        91 %    $ 31,540        91 %    $ (7,514 )         (24 )%
 Publisher Solutions      2,451         9 %       3,096         9 %        (645 )         (21 )%

 Total revenue         $ 26,477       100 %    $ 34,636       100 %    $ (8,159 )         (24 )%

We recognized $13.2 and $26.5 million of total revenue during the three and six months ended June 30, 2009, respectively. Total revenue for the three and six months ended June 30, 2009 was down 23% and 24%, respectively, from the $17.1 million and $34.6 million recognized during the comparable three and six months ended June 30, 2008. We attribute the $3.9 million decrease in the three months ended June 30, 2009 primarily to a 25% decrease in average revenue-per-click (RPC) compared to the same period in 2008. For the six months ended June 30, 2009, revenues were lower by $8.2 million compared to the comparable period in 2008, due mostly to a 33% decrease in RPC, which was partially offset by a 13% increase in paid clicks.

We continue to be dependent upon a few customers for a significant percentage of our revenue. For the three months ended June 30, 2009 and 2008, two customers accounted for a combined 28% of revenue. For the six months ended June 30, 2009 and 2008, those same two customers accounted for a combined 29% and 30%, respectively. One of these two customers, IAC Search and Media ("IAC"), notified us in May 2009 that it does not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement, which provides for certain Publisher Solutions services when it expires on December 31, 2009. For the three and six months ended June 30, 2009, IAC accounted for $1.0 million and 2.1 million, or 79% and 84%, respectively, of Publisher Solutions Revenue. Advertiser Network revenue derived from IAC, which is covered under separate distribution agreements, totaled $1.3 million and $2.9 million for the three and six months ended June 30, 2009. IAC has not indicated to us an intent to terminate these separate distribution agreements.

We recognized Advertiser Networks revenue of $12.0 million and $24.0 million, respectively, during the three and six months ended June 30, 2009, down 24% from the $15.7 million and $31.5 million, respectively, recognized during the three and six months ended June 30, 2008. Revenue from Advertiser Networks decreased . . .