Forward-Looking Statements

The following discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and the Notes to those statements which appear elsewhere in this Quarterly Report on Form 10-Q. The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as "believes," "intends," "expects," "anticipates," "plans," "may," "will" and similar expressions to identify forward-looking statements. Discussions containing forward-looking statements may be found in the material set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and in other sections of this report. All forward-looking statements, including, but not limited to, projections, expectations or estimates concerning our business, including demand for our products and services, mix of revenue sources, ability to control and/or reduce operating expenses, anticipated gross margins and operating results, cost savings, product development efforts, general outlook of our business and industry, future profits or losses, competitive position, share-based compensation, 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 elsewhere in this report may occur.

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

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are discussed in our Annual Report on Form 10-K for the year ended December 31, 2010. As of September 30, 2011, there had been no material changes to our critical accounting policies and estimates.

Business Overview

LookSmart is a search advertising network solutions company that provides relevant solutions for search advertising customers. LookSmart was organized in 1996 and is incorporated in the State of Delaware.

LookSmart operates in a large online search advertising ecosystem serving ads that target user queries on partner sites. We operate in the middle of this ecosystem, acquiring search queries from a variety of sources and matching them with the keywords of our search advertising customers. Our largest category of customers has been intermediaries, the majority of which purchase clicks to sell into the affiliate networks of the large search engine providers. Another category of customers are direct advertisers and their agencies whose objective is to obtain conversions or sales from the clicks, while others want unique page views. The last category of customers is self-service advertisers that sign-up online and pay by credit card.

LookSmart offers search advertising customers targeted search via a monitored search advertising distribution network using the Company's "AdCenter" platform technology. The Company's search advertising network includes publishers and search advertising customers, including intermediaries and direct advertising customers and their agencies as well as self-service customers in the United States and certain other countries. The Company's application programming interface ("API") allows search advertising customers and their advertising agencies to connect any type of marketing or reporting software with minimal effort, for easier access, management, and optimization of search advertising campaigns.

LookSmart also offers publishers licensed private-label search advertiser network solutions based on its AdCenter platform technology ("Publisher Solutions"). Publisher Solutions consist of hosted auction-based ad serving with an ad backfill capability that allows publishers and portals to manage their advertiser relationships, distribution channels and accounts.

In the first quarter of 2008, management made the decision to exit its remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. The results of operations of consumer product activities, including related gains, have been classified as discontinued operations for all periods presented in the accompanying Unaudited Consolidated Statements of Operations (see Note 2). At September 30, 2011, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology, and other assets.

Results of Operations

Overview of the Three and Nine Months Ended September 30, 2011

The following tables set forth selected information concerning our results of
operations for the periods indicated (in thousands):

                                                  Three Months Ended September 30,
                                         % of                          % of          Dollar           %
                          2011         Revenue          2010         Revenue         Change         Change
Revenue                 $   7,356          100.0 %    $  11,275          100.0 %    $  (3,919 )          (35 %)
Cost of revenue             4,187           56.9 %        6,324           56.1 %       (2,137 )          (34 %)
Gross profit                3,169           43.1 %        4,951           43.9 %       (1,782 )          (36 %)
Operating expenses:
Sales and marketing           566            7.7 %          954            8.5 %         (388 )          (41 %)
Product development
and technical
operations                  1,767           24.0 %        1,812           16.0 %          (45 )           (2 %)
General and
administrative              1,065           14.5 %        1,546           13.7 %         (481 )          (31 %)
Total operating
expenses                    3,398           46.2 %        4,312           38.2 %         (914 )          (21 %)
Income (loss) from
operations                   (229 )         (3.1 %)         639            5.7 %         (868 )         (136 %)
Non-operating income
(expense), net                  9            0.1 %          (10 )         (0.1 %)          19           (190 %)
Income (loss) from
continuing operations
before income taxes          (220 )         (3.0 %)         629            5.6 %         (849 )         (135 %)
Income tax expense             (4 )         (0.1 %)           -            0.0 %           (4 )            0 %
Income (loss) from
continuing operations        (224 )         (3.1 %)         629            5.6 %         (853 )         (136 %)
Income from
discontinued
operations, net of
income taxes                    -            0.0 %           89            0.8 %          (89 )         (100 %)
Net income (loss)       $    (224 )         (3.1 %)   $     718            6.4 %    $    (942 )         (131 %)



                                                 Nine Months Ended September 30,
                                         % of                          % of         Dollar           %
                          2011         Revenue          2010         Revenue        Change        Change
Revenue                 $  22,350          100.0 %    $  37,578          100.0 %   $ (15,228 )         (41 %)
Cost of revenue            12,281           54.9 %       22,885           60.9 %     (10,604 )         (46 %)
Gross profit               10,069           45.1 %       14,693           39.1 %      (4,624 )         (31 %)
Operating expenses:
Sales and marketing         1,768            7.9 %        3,383            9.0 %      (1,615 )         (48 %)
Product development
and technical
operations                  4,911           22.0 %        5,804           15.4 %        (893 )         (15 %)
General and
administrative              3,492           15.6 %        4,907           13.1 %      (1,415 )         (29 %)
Restructuring charge          889            4.0 %            -            0.0 %         889             0 %
Total operating
expenses                   11,060           49.5 %       14,094           37.5 %      (3,034 )         (22 %)
Income (loss) from
operations                   (991 )         (4.4 %)         599            1.6 %      (1,590 )        (265 %)
Non-operating income
(expense), net                329            1.5 %           (8 )          0.0 %         337         (4213 %)
Income (loss) from
continuing operations
before income taxes          (662 )         (2.9 %)         591            1.6 %      (1,253 )        (212 %)
Income tax expense             (3 )          0.0 %           (5 )          0.0 %           2           (40 %)
Income (loss) from
continuing operations        (665 )         (2.9 %)         586            1.6 %      (1,251 )        (213 %)
Income from
discontinued
operations, net of
income taxes                    -            0.0 %          267            0.7 %        (267 )        (100 %)
Net income (loss)       $    (665 )         (2.9 %)   $     853            2.3 %   $  (1,518 )        (178 %)

Revenue

Revenue is derived from two service offerings or "products" of LookSmart Ltd.
(the "Company"): Advertiser Networks and Publisher Solutions. Total revenue and
revenue from Advertiser Networks and Publisher Solutions for the three and nine
months ended September 30, 2011 and 2010, were as follows (in thousands):

                                           Three Months Ended September 30,
                                    % of                       % of         Dollar         %
                       2011        Revenue        2010        Revenue       Change       Change
Advertiser Networks   $ 7,043            96 %   $ 10,397            92 %   $ (3,354 )        (32 %)
Publisher Solutions       313             4 %        878             8 %       (565 )        (64 %)
Total revenue         $ 7,356           100 %   $ 11,275           100 %   $ (3,919 )        (35 %)



                                            Nine Months Ended September 30,
                                     % of                       % of         Dollar          %
                         2011       Revenue        2010        Revenue       Change        Change
Advertiser Networks   $ 21,504            96 %   $ 34,930            93 %   $ (13,426 )        (38 %)
Publisher Solutions        846             4 %      2,648             7 %      (1,802 )        (68 %)
Total revenue         $ 22,350           100 %   $ 37,578           100 %   $ (15,228 )        (41 %)

The decrease in Advertiser Networks revenue for the three and nine months ended September 30, 2011 as compared to the same periods in 2010 is attributed to a decline in paid clicks and average revenue-per-click ("RPC"). RPC and paid click changes were the result of lower revenues from our intermediaries in the comparable periods. Yahoo! Partners, our largest customer group, were affected significantly by reduced payments following the Yahoo!-Bing Search Alliance integration which consequently resulted in lower revenues to us. Total paid clicks decreased 14% to 151 million for the three months ended September 30, 2011, compared to 175 million for the three months ended September 30, 2010. During the same three month period, average RPC decreased 21%, from $0.059 to $0.047. Total paid clicks decreased 27% to 442 million for the nine months ended September 30, 2011, compared to 609 million for the nine months ended September 30, 2010. During the same nine month period, average RPC decreased 15%, from $0.057 to $0.049. Quarter-over-quarter metrics are increasing; total paid clicks of 151 million in the third quarter of 2011 increased 3% from 146 million in the second quarter of 2011 while average RPC increased 8% in the third quarter of 2011 compared to the second quarter of 2011. Going forward, we will continue to attempt to increase our revenue primarily with our intermediaries and through performance based pricing models targeting direct advertisers and their agencies.

The decrease in Publisher Solutions revenue for the three and nine months ended September 30, 2011 as compared to the same periods in 2010 is attributed to reduced revenue from IAC Search and Media, Inc. ("IAC") related to the termination of an agreement with IAC on October 31, 2010. We did not record any Publisher Solutions revenue from IAC during the three and nine months ended September 30, 2011, compared to $0.6 million, or 74% of Publisher Solutions revenue, and $1.9 million, or 72% of Publisher Solutions revenue, during the three and nine months ended September 30, 2010, respectively.

Cost of Revenue and Gross Margin

Cost of revenue, consisting of TAC, costs paid to our distribution network
partners, connectivity costs, hosting expenses, commissions paid to advertising
agencies, and credit card fees were as follows for the three and nine months
ended September 30, 2011 and 2010 (in thousands):

                                                 Three Months Ended September 30,
                                         % of                         % of         Dollar           %
                          2011         Revenue         2010         Revenue        Change         Change
Traffic acquisition
costs                   $   3,803             52 %   $   5,912             52 %   $  (2,109 )          (36 %)
Other costs                   384              5 %         412              4 %         (28 )           (7 %)
Total cost of revenue   $   4,187             57 %   $   6,324             56 %   $  (2,137 )          (34 %)
Traffic acquisition
costs as percentage
of Advertiser

                                                 Nine Months Ended September 30,
                                         % of                         % of         Dollar           %
                           2011        Revenue         2010         Revenue        Change         Change
Traffic acquisition
costs                   $  11,106             50 %   $  21,336             57 %   $ (10,230 )          (48 %)
Other costs                 1,175              5 %       1,549              4 %        (374 )          (24 %)
Total cost of revenue   $  12,281             55 %   $  22,885             61 %   $ (10,604 )          (46 %)
Traffic acquisition
costs as percentage
of Advertiser

Our TAC decrease as a percentage of associated revenue in the nine months ended September 30, 2011 is primarily attributed to optimization of bids/prices paid for different sources of traffic and keywords.

Our other costs of revenue, which consists primarily of co-location costs and credit card processing fees, decreased due to the significant duplicate costs incurred during the first half of 2010 associated with the move to a new co-location facility.

Operating Expenses

Operating expenses for the three and nine months ended September 30, 2011 as compared to the same period in 2010 decreased $0.9 million and $3.0 million, respectively. The decrease is largely due to lower headcount resulting from a reduction in workforce in the first quarter of 2011. Since the reduction in workforce in the first quarter of 2011, we have been increasing our headcount in sales, product development and account management. We plan to continue increasing the workforce which will result in comparatively higher operating expenses; however, this planned increase in headcount and associated expense will continue to be closely evaluated relative to operating margin.

Operating expenses consist of sales and marketing, product development and technical operations, general and administrative, and restructuring charges for the three and nine months ended September 30, 2011 and 2010; and were as follows (in thousands):

                                                  Three Months Ended September 30,
                                         % of                          % of           Dollar           %
                          2011          Revenue         2010          Revenue         Change         Change
Sales and marketing     $     566               8 %   $     954               8 %   $     (388 )          (41 %)
Product development
and technical
operations                  1,767              24 %       1,812              16 %          (45 )           (2 %)
General and
administrative              1,065              14 %       1,546              14 %         (481 )          (31 %)
Total operating
expenses                $   3,398              46 %   $   4,312              38 %   $     (914 )          (21 %)



                                                  Nine Months Ended September 30,
                                         % of                          % of          Dollar           %
                          2011          Revenue         2010          Revenue        Change         Change
Sales and marketing     $   1,768               8 %   $   3,383               9 %   $  (1,615 )          (48 %)
Product development
and technical
operations                  4,911              22 %       5,804              16 %        (893 )          (15 %)
General and
administrative              3,492              15 %       4,907              13 %      (1,415 )          (29 %)
Restructuring charge          889               4 %           -               0 %         889              0 %
Total operating
expenses                $  11,060              49 %   $  14,094              38 %   $  (3,034 )          (22 %)

Sales and Marketing

Sales and marketing expenses include salaries, commissions, share-based compensation and other costs of employment for our sales force, sales administration and customer service staff and marketing personnel, overhead, facilities, allocation of depreciation and the provision for, and reductions of, the allowance 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.

The reduction in sales and marketing expenses for the three and nine months ended September 30, 2011, is primarily due to lower compensation related expense associated with lower headcount, and a reduction in marketing expenses.

Product Development and Technical Operations

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

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

Product development and technical operations and capitalized software development costs for the three and nine months ended September 30, 2011 and 2010 were as follows (in thousands):

                                                   Three Months Ended September 30,
                                         % of                             %             Dollar           %
                          2011          Revenue          2010         of Revenue        Change         Change
Product development
and technical
operations costs        $   1,853              25 %    $   1,988               18 %    $    (135 )           (7 %)
Capitalized software
development costs             (86 )            (1 %)        (176 )             (2 %)          90            (51 %)
Total product
development and
technical operations
expense                 $   1,767              24 %    $   1,812               16 %    $     (45 )           (2 %)

                                                    Nine Months Ended September 30,
                                         % of                            % of           Dollar           %
                             2011       Revenue          2010          Revenue          Change         Change
Product development
and technical
operations costs        $   5,260              24 %    $   6,356               17 %    $  (1,096 )          (17 %)
Capitalized software
development costs            (349 )            (2 %)        (552 )             (2 %)         203            (37 %)
Total product
development and
technical operations
expense                 $   4,911              22 %    $   5,804               15 %    $    (893 )          (15 %)

The reduction in product development and technical operations expense, net of capitalized software development costs for the three and nine months ended September 30, 2011 is primarily due to lower compensation related expense and lower depreciation expense, which was partially offset by lower capitalized software development.

General and Administrative

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

The reduction in general and administrative expenses for the three and nine months ended September 30, 2011 is due to lower compensation-related expense associated with lower headcount and reductions in legal and professional fees.

Other Items

The tables below set forth other continuing operations data for the three and
nine months ended September 30, 2011 and 2010 (in thousands):

                                                    Three Months Ended September 30,
                                           % of                           % of           Dollar           %
                           2011          Revenue          2010          Revenue          Change         Change
Non-operating income
(expense), net
Interest income         $       21                0 %   $      17                0 %   $        4             24 %
Interest expense               (11 )              0 %         (34 )              0 %           23            (68 %)
Other income
(expense), net                  (1 )              0 %           7                0 %           (8 )         (114 %)
Total non-operating
income (expense), net   $        9                0 %   $     (10 )              0 %   $       19           (190 %)

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



                                                   Nine Months Ended September 30,
                                          % of                           % of           Dollar           %
                           2011         Revenue          2010          Revenue          Change        Change
Non-operating income
(expense), net
Interest income         $      68                0 %   $      50                0 %   $       18            36 %
Interest expense              (64 )              0 %        (117 )              0 %           53           (45 %)
Other income, net             325                1 %          59                0 %          266           451 %
Total non-operating
income (expense), net   $     329                1 %   $      (8 )              0 %   $      337         (4213 %)

Income tax expense      $      (3 )              0 %   $      (5 )              0 %   $        2           (40 %)

Interest

Interest expense, primarily consisting of interest paid on capital leases, decreased an insignificant amount during the three and nine months ended September 30, 2011 as compared to the three and nine months ended September 30, 2010. This decrease was primarily due to a reduction in capital lease obligations.

Other Income

In 2008, the Company established a settlement fund related to a class action lawsuit in which the Company was named as a defendant, Lane's Gifts and Collectibles, L.L.C., v. Yahoo! Inc. (the "Fund"). In the second quarter of 2011, the Company determined that all settlements related to the Fund had been paid. The Fund was closed on June 30, 2011 and the Company recorded $0.3 million . . .