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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, 2005



OR



| ̈ | 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

(Address of Principal Executive Offices and Zip Code)



(415) 348-7000

(Registrants Telephone Number, Including Area Code)



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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ̈



As of August 1, 2005, there were 113,853,274 shares of the registrants common stock outstanding.



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FORM 10-Q

INDEX



|                             |  |                                                                                                                                  |  |     
|---------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------- |  | ----
|                             |  |                                                                                                                                  |  | Page
|PART I FINANCIAL INFORMATION |  | 3                                                                                                                               
|                             |  |                                                                                                                                 
|ITEM 1:                      |  | Condensed Consolidated Financial Statements (unaudited)                                                                          |  | 3   
|                             |  | Condensed Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004                                                  |  | 3   
|                             |  | Condensed Consolidated Statements of Operations and Comprehensive Loss for the three and six months ended June 30, 2005 and 2004 |  | 4   
|                             |  | Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2004                                  |  | 5   
|                             |  | Notes to Condensed Consolidated Financial Statements                                                                             |  | 6   
|                             |  |                                                                                                                                 
|ITEM 2:                      |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                            |  | 16  
|                             |  | Risk Factors Affecting Operating Results                                                                                         |  | 25  
|                             |  |                                                                                                                                 
|ITEM 3:                      |  | Quantitative and Qualitative Disclosures About Market Risk                                                                       |  | 34  
|                             |  |                                                                                                                                 
|ITEM 4:                      |  | Controls and Procedures                                                                                                          |  | 34  
|                             | 
|PART II OTHER INFORMATION    |  | 35                                                                                                                              
|                             |  |                                                                                                                                 
|ITEM 1:                      |  | Legal Proceedings                                                                                                                |  | 35  
|                             |  |                                                                                                                                 
|ITEM 6:                      |  | Exhibits                                                                                                                         |  | 36  
|                             |  |                                                                                                                                 
|                             |  | Signature                                                                                                                        |  | 36  
|                             | 
|EXHIBIT INDEX                |  | 37                                                                                                                              



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PART I  FINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------



LOOKSMART, LTD.



CONDENSED
CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

(Unaudited)



|                                                                                                                                                                                                         |  |              |          |   |                  |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                                                                                         |  | June 30,2005 |          |   | December 31,2004 |  
|ASSETS                                                                                                                                                                                                   |  |              |          |   |                  |   |          |  
|Current assets:                                                                                                                                                                                          |  |              |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                                                                                |  | $            | 43,602   |   |                  | $ | 45,054   |  
|Short term investments                                                                                                                                                                                   |  |              | 7,685    |   |                  |   | 7,648    |  
|Trade accounts receivable, net of allowance for doubtful accounts of $302 at June 30, 2005 and $497 at December 31, 2004 and allowance for
returns of $37 at June 30, 2005 and $965 at December 31, 2004 |  |              | 2,272    |   |                  |   | 3,880    |  
|Prepaid expenses                                                                                                                                                                                         |  |              | 575      |   |                  |   | 1,042    |  
|Other current assets                                                                                                                                                                                     |  |              | 884      |   |                  |   | 1,174    |  
|                                                                                                                                                                                                         |  |              |          |   |                  |   |          |  
|Total current assets                                                                                                                                                                                     |  |              | 55,018   |   |                  |   | 58,798   |  
|Long term investments                                                                                                                                                                                    |  |              | 9,822    |   |                  |   | 11,198   |  
|Property and equipment, net                                                                                                                                                                              |  |              | 4,959    |   |                  |   | 5,988    |  
|Security deposits and other assets                                                                                                                                                                       |  |              | 2,704    |   |                  |   | 3,318    |  
|Intangible assets, net                                                                                                                                                                                   |  |              | 6,148    |   |                  |   | 7,364    |  
|Goodwill                                                                                                                                                                                                 |  |              | 14,422   |   |                  |   | 14,422   |  
|                                                                                                                                                                                                         |  |              |          |   |                  |   |          |  
|Total assets                                                                                                                                                                                             |  | $            | 93,073   |   |                  | $ | 101,088  |  
|                                                                                                                                                                                                         |  |              |          |   |                  |   |          |  
|LIABILITIES & STOCKHOLDERS EQUITY                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|Current liabilities:                                                                                                                                                                                     |  |              |          |   |                  |   |          |  
|Trade accounts payable                                                                                                                                                                                   |  |              | 2,398    |   |                  |   | 360      |  
|Accrued expenses and other current liabilities                                                                                                                                                           |  |              | 6,831    |   |                  |   | 8,032    |  
|Customer deposits                                                                                                                                                                                        |  |              | 1,522    |   |                  |   | 1,525    |  
|                                                                                                                                                                                                         |  |              |          |   |                  |   |          |  
|Total current liabilities                                                                                                                                                                                |  |              | 10,751   |   |                  |   | 9,917    |  
|Other long term liabilities, net of current portion                                                                                                                                                      |  |              | 5,948    |   |                  |   | 5,071    |  
|                                                                                                                                                                                                         |  |              |          |   |                  |   |          |  
|Total liabilities                                                                                                                                                                                        |  |              | 16,699   |   |                  |   | 14,988   |  
|Commitments and contingencies (Note 5)                                                                                                                                                                   |  |              |          |   |                  |   |          |  
|Stockholders equity:                                                                                                                                                                                    |  |              |          |   |                  |   |          |  
|Convertible preferred stock, $0.001 par value; Authorized: 5,000 at June 30, 2005 and December 31, 2004; Issued and Outstanding: none at June
30, 2005 and December 31, 2004                             |  |              |         |   |                  |   |         |  
|Common stock, $.001 par value; Authorized: 200,000 at June 30, 2005 and December 31, 2004; Issued and Outstanding: 114,407 and 114,271 at June
30, 2005 and December 31, 2004, respectively              |  |              | 113      |   |                  |   | 113      |  
|Additional paid-in capital                                                                                                                                                                               |  |              | 271,647  |   |                  |   | 271,604  |  
|Other equity                                                                                                                                                                                             |  |              | 382      |   |                  |   | 395      |  
|Accumulated deficit                                                                                                                                                                                      |  |              | (195,768 | ) |                  |   | (186,012 | )
|                                                                                                                                                                                                         |  |              |          |   |                  |   |          |  
|Total stockholders equity                                                                                                                                                                               |  |              | 76,374   |   |                  |   | 86,100   |  
|                                                                                                                                                                                                         |  |              |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                               |  | $            | 93,073   |   |                  | $ | 101,088  |  
|                                                                                                                                                                                                         |  |              |          |   |                  |   |          |  



The accompanying notes
are an integral part of these condensed consolidated financial statements.



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LOOKSMART, LTD.



CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE

LOSS

(In thousands, except per share data)

(Unaudited)



|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|----------------------------------------------------------------- |  | ------------------------- | ------- | - | ----------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                  |  | Three Months EndedJune 30 |         |   | Six Months EndedJune 30 |  
|                                                                  |  | 2005                      |         |   | 2004                    |   |         | 2005 |  |   | 2004    |  
|Revenues                                                          |  | $                         | 10,225  |   |                         | $ | 19,131  |      |  | $ | 22,226  |   |  | $ | 42,981  |  
|Cost of revenues                                                  |  |                           | 6,620   |   |                         |   | 11,003  |      |  |   | 14,912  |   |  |   | 24,826  |  
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Gross profit                                                      |  |                           | 3,605   |   |                         |   | 8,128   |      |  |   | 7,314   |   |  |   | 18,155  |  
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Operating expenses:                                               |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Sales and marketing                                               |  |                           | 1,714   |   |                         |   | 1,794   |      |  |   | 3,349   |   |  |   | 4,549   |  
|Product development                                               |  |                           | 4,332   |   |                         |   | 5,991   |      |  |   | 9,097   |   |  |   | 13,282  |  
|General and administrative                                        |  |                           | 1,539   |   |                         |   | 2,252   |      |  |   | 3,721   |   |  |   | 5,363   |  
|Restructuring charges                                             |  |                           | 1,879   |   |                         |   | 420     |      |  |   | 1,904   |   |  |   | 4,054   |  
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Total operating expenses                                          |  |                           | 9,464   |   |                         |   | 10,457  |      |  |   | 18,071  |   |  |   | 27,248  |  
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Loss from operations                                              |  |                           | (5,859  | ) |                         |   | (2,329  | )    |  |   | (10,757 | ) |  |   | (9,093  | )
|Non-operating income                                              |  |                           | 426     |   |                         |   | 52      |      |  |   | 904     |   |  |   | 147     |  
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Loss from continuing operations before income taxes               |  |                           | (5,433  | ) |                         |   | (2,277  | )    |  |   | (9,853  | ) |  |   | (8,946  | )
|Income tax expense                                                |  |                           | (11     | ) |                         |   |        |      |  |   | (13     | ) |  |   |        |  
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Loss from continuing operations                                   |  |                           | (5,444  | ) |                         |   | (2,277  | )    |  |   | (9,866  | ) |  |   | (8,946  | )
|Gain from discontinued operations, net of tax                     |  |                           | 28      |   |                         |   | 1,040   |      |  |   | 110     |   |  |   | 584     |  
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Net loss                                                          |  |                           | (5,416  | ) |                         |   | (1,237  | )    |  |   | (9,756  | ) |  |   | (8,362  | )
|Other comprehensive loss:                                         |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Change in unrealized gain (loss) on securities during the period  |  |                           | 37      |   |                         |   | 3       |      |  |   | (40     | ) |  |   | 1       |  
|Change in translation adjustment                                  |  |                           |        |   |                         |   | (310    | )    |  |   |        |   |  |   | 16      |  
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Comprehensive loss                                                |  | $                         | (5,379  | ) |                         | $ | (1,544  | )    |  | $ | (9,796  | ) |  | $ | (8,345  | )
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Basic and diluted net loss per common share:                      |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Loss from continuing operations                                   |  | $                         | (0.05   | ) |                         | $ | (0.02   | )    |  | $ | (0.09   | ) |  | $ | (0.08   | )
|Gain from discontinued operations, net of tax                     |  |                           | 0.00    |   |                         |   | 0.01    |      |  |   | 0.00    |   |  |   | 0.01    |  
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Net loss                                                          |  | $                         | (0.05   | ) |                         | $ | (0.01   | )    |  | $ | (0.09   | ) |  | $ | (0.08   | )
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  
|Weighted average shares outstanding used in per share calculation |  |                           | 113,784 |   |                         |   | 111,235 |      |  |   | 113,761 |   |  |   | 109,716 |  
|                                                                  |  |                           |         |   |                         |   |         |      |  |   |         |   |  |   |         |  



The accompanying notes
are an integral part of these condensed consolidated financial statements.



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LOOKSMART, LTD.



CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)



|                                                                                           |  |                          |        |   |      |   |         |  
|------------------------------------------------------------------------------------------ |  | ------------------------ | ------ | - | ---- | - | ------- | -
|                                                                                           |  | Six Months EndedJune 30, |       
|                                                                                           |  | 2005                     |        |   | 2004 |  
|Cash flows from operating activities:                                                      |  |                          |        |   |      |   |         |  
|Net loss                                                                                   |  | $                        | (9,756 | ) |      | $ | (8,362  | )
|Adjustments to reconcile net loss to net cash used in operating activities:                |  |                          |        |   |      |   |         |  
|Depreciation and amortization                                                              |  |                          | 4,010  |   |      |   | 3,936   |  
|Stock based compensation (reversal)                                                        |  |                          | (10    | ) |      |   | 61      |  
|Loss (gain) from sale of assets and other non-cash charges                                 |  |                          | 209    |   |      |   | (771    | )
|Changes in operating assets and liabilities, net of effects of acquisitions and disposals: |  |                          |        |   |      |   |         |  
|Trade accounts receivable, net                                                             |  |                          | 1,608  |   |      |   | 16,059  |  
|Prepaid expenses                                                                           |  |                          | 467    |   |      |   | 1,137   |  
|Other assets                                                                               |  |                          | 290    |   |      |   | 365     |  
|Trade accounts payable                                                                     |  |                          | 2,038  |   |      |   | (1,669  | )
|Accrued expenses and other current liabilities                                             |  |                          | (301   | ) |      |   | (14,030 | )
|Customer deposits                                                                          |  |                          | (3     | ) |      |   | (1,879  | )
|                                                                                           |  |                          |        |   |      |   |         |  
|Net cash used in operating activities                                                      |  |                          | (1,448 | ) |      |   | (5,153  | )
|                                                                                           |  |                          |        |   |      |   |         |  
|Cash flows from investing activities:                                                      |  |                          |        |   |      |   |         |  
|Purchase of investments                                                                    |  |                          | (5,791 | ) |      |   | (22,133 | )
|Maturities of investments                                                                  |  |                          | 1,881  |   |      |   |        |  
|Proceeds from sale of investments                                                          |  |                          | 5,000  |   |      |   | 82      |  
|Payments for property, equipment and capitalized software development                      |  |                          | (1,150 | ) |      |   | (1,800  | )
|Proceeds from sale of discontinued operations                                              |  |                          |       |   |      |   | 1,484   |  
|Acquisition of NetNanny                                                                    |  |                          |       |   |      |   | (877    | )
|                                                                                           |  |                          |        |   |      |   |         |  
|Net cash used in investing activities                                                      |  |                          | (60    | ) |      |   | (23,244 | )
|                                                                                           |  |                          |        |   |      |   |         |  
|Cash flows from financing activities:                                                      |  |                          |        |   |      |   |         |  
|Repayment of notes                                                                         |  |                          | (25    | ) |      |   | (50     | )
|Proceeds from issuance of common stock                                                     |  |                          | 81     |   |      |   | 3,557   |  
|                                                                                           |  |                          |        |   |      |   |         |  
|Net cash provided by financing activities                                                  |  |                          | 56     |   |      |   | 3,507   |  
|                                                                                           |  |                          |        |   |      |   |         |  
|Effect of exchange rate changes on cash                                                    |  |                          |       |   |      |   | (16     | )
|                                                                                           |  |                          |        |   |      |   |         |  
|Decrease in cash and cash equivalents                                                      |  |                          | (1,452 | ) |      |   | (24,906 | )
|Cash and cash equivalents, beginning of period                                             |  |                          | 45,054 |   |      |   | 63,866  |  
|                                                                                           |  |                          |        |   |      |   |         |  
|Cash and cash equivalents, end of period                                                   |  | $                        | 43,602 |   |      | $ | 38,960  |  
|                                                                                           |  |                          |        |   |      |   |         |  
|Supplemental disclosure of non-cash investing activities:                                  |  |                          |        |   |      |   |         |  
|Issuance of common stock as consideration in a business combination                        |  | $                        |       |   |      | $ | 4,234   |  



The accompanying notes
are an integral part of these condensed consolidated financial statements.



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LOOKSMART, LTD.



NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



|1. | Summary of Significant Accounting Policies:
|-- | -------------------------------------------



Nature of Business and Principles of Consolidation



LookSmart is a provider of technology, content and tools for publishers, a provider of search results, via sites, for consumers, as well as a provider of
marketing products for advertisers who want to be included in relevant search results on LookSmart sites or on our distribution partners sites.



The unaudited condensed consolidated financial statements as of June 30, 2005 and for the three and six months ended June 30, 2005 include the accounts of
the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.



In the first quarter of 2004, the Company signed agreements to sell certain assets and activities of its Australian, British and Japanese subsidiaries.
Accordingly, the condensed consolidated results of operations have been recast to remove the results of the international operations from continuing operations for all periods presented in these condensed consolidated financial statements. Results
of the international operations are included in the separate line item Gain from discontinued operations, net of tax, for all periods presented in these condensed consolidated financial statements. The results of the discontinued operations are
summarized in Note 9 to these financial statements.



Unaudited Interim Financial Information



The
accompanying unaudited condensed consolidated financial statements as of June 30, 2005 and for the three and six months ended June 30, 2005 reflect all adjustments which are normal and recurring in nature and, in the opinion of management, are
necessary for a fair statement of the results of operations for the periods shown. These 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, 2004. The condensed consolidated balance sheet as of December 31, 2004 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 financials statements. The results of operations for the interim period ended June 30, 2005 are not necessarily indicative of results to be
expected for the full year. These unaudited interim condensed consolidated financial statements should be read in conjunction with LookSmarts audited consolidated financial statements and notes for the year ended December 31, 2004 included in
its Annual Report on Form 10-K filed with the Securities and Exchange Commission.



Concentration of Credit Risk



Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, short-term investments, long-term investments and accounts receivable. As of June 30, 2005 and December 31,
2004, one financial institution managed all of the Companys cash, cash equivalents and investments. The fair values of these investments are subject to fluctuation based on market prices.



Accounts receivable are typically unsecured and are derived from revenue
earned from customers. The Company performs ongoing credit evaluations of its customers and maintains allowances for probable credit losses. The Company applies judgment as to its ability to collect outstanding receivables based



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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 a general allowance based on the length of time other receivables are past due. Historically, such losses have been within managements expectations. As of June 30, 2005, one customer accounted for 12% of the
accounts receivable balance. No one customer accounted for 10 percent or more of the accounts receivable balance as of December 31, 2004.



Revenue Concentrations



The Company derived the following percentages of its revenue from its relationship with significant traffic providers:



|          |  |                            |   |  |                          |   |  |      |   |  |      |  
|--------- |  | -------------------------- | - |  | ------------------------ | - |  | ---- | - |  | ---- | -
|          |  | Three Months EndedJune 30, |   |  | Six Months EndedJune 30, |  
|          |  | 2005                       |   |  | 2004                     |   |  | 2005 |   |  | 2004 |  
|Company 1 |  | 18                         | % |  | 18                       | % |  | 21   | % |  | 14   | %
|Company 2 |  | 13                         | % |  | 9                        | % |  | 15   | % |  | 8    | %
|Company 3 |  | 10                         | % |  | 0                        | % |  | 10   | % |  | 0    | %
|Company 4 |  | 3                          | % |  | 16                       | % |  | 3    | % |  | 18   | %
|Company 5 |  | 1                          | % |  | 9                        | % |  | 2    | % |  | 22   | %



Use of Estimates
and Assumptions



The condensed 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, revenues, expenses, and contingent
assets and liabilities during the reporting period. The Company bases its estimates on various factors and information which may include, but 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. Actual results could differ from those estimates.



Reclassifications



Certain prior years balances have been reclassified to conform to the current years presentation. The reclassifications had no material impact
on net loss or equity.



Stock-Based Compensation



The Company accounts for stock-based employee
compensation using the intrinsic method under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB No. 25) and related interpretations. Under APB No. 25,
compensation cost is equal to the difference, if any, on the date of grant between the fair value of the Companys stock and the amount an employee must pay to acquire the stock. Statement of Financial Accounting Standards SFAS 123 (SFAS
123), Accounting for Stock-based Compensation, established accounting and disclosure requirements using a fair value based method of accounting for stock-based employee compensation plans. As allowed by SFAS 123, the Company has
elected to continue to apply the intrinsic value based method of accounting described above, and has adopted the disclosure requirements of SFAS 123 and related Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure (SFAS 148).



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The following table illustrates the effect on net loss and net loss per share if the Company had applied
the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except per share data):



|                                                                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                      |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                                                                                      |  | 2005                       |        |   | 2004                     |   |        | 2005 |  |   | 2004    |  
|Net loss as reported                                                                                                  |  | $                          | (5,416 | ) |                          | $ | (1,237 | )    |  | $ | (9,756  | ) |  | $ | (8,362  | )
|Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects              |  |                            | (13    | ) |                          |   | 11     |      |  |   | 10      |   |  |   | 61      |  
|Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of tax |  |                            | (496   | ) |                          |   | (1,379 | )    |  |   | (1,065  | ) |  |   | (3,504  | )
|                                                                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Pro forma net loss                                                                                                    |  | $                          | (5,925 | ) |                          | $ | (2,605 | )    |  | $ | (10,811 | ) |  | $ | (11,805 | )
|                                                                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net loss per share:                                                                                                   |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|As reported                                                                                                           |  | $                          | (0.05  | ) |                          | $ | (0.01  | )    |  | $ | (0.09   | ) |  | $ | (0.08   | )
|Pro forma                                                                                                             |  |                            | (0.05  | ) |                          |   | (0.02  | )    |  |   | (0.10   | ) |  |   | (0.11   | )



For purposes of
computing pro forma net loss, the Company estimates the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are fully transferable, characteristics not present in the Companys option grants. Additionally, option valuation models require the input of highly subjective assumptions, including the
expected volatility of the stock price. Because the Companys employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the
fair value estimates, in managements opinion, the existing models do not provide a reliable single measure of the fair value of its stock-based awards.



Options vest over several years, and new option awards are generally granted each year. Because of this, the pro forma amounts shown above may not be
representative of the pro forma effect on reported net loss in future years.



Segment Information



The Company operates in one primary business segment, listings. As of June 30, 2005 and December 31, 2004, all of the Companys revenues included in continuing operations were generated in the United States of America. See Note 9
regarding foreign revenue reported as discontinued operations. All long-lived assets are located in the United States of America.



Recently Issued Accounting Pronouncements



In May 2005, the FASB issued FASB 154 (FASB 154), Accounting Changes and Error Correctionsa replacement of APB Opinion No. 20 and
FASB Statement No. 3. This Statement replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the
accounting for and reporting of a change in accounting principle. FASB 154 applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement
does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. This statement is effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005.



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In December 2004, the Financial Accounting Standards Board (FASB) enacted Statement of
Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation - revised 2004, Share-Based Payment (SFAS 123R), which replaces SFAS 123 and supersedes APB Opinion No. 25
(APB 25), Accounting for Stock Issued to Employees. SFAS 123R requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the
recording of such expense in our consolidated statements of operations. The Company is required to adopt SFAS 123R beginning January 1, 2006.



The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. See Note 1 in the Notes
to Consolidated Financial Statements for the pro forma net loss and net loss per share amounts, for the three and six months ended June 30, 2005 and June 30, 2004, as if we had used a fair-value-based method similar to the methods required under
SFAS 123R to measure compensation expense for employee stock incentive awards. The Company is evaluating the requirements under SFAS 123R including the fair value model and transition method to select and expects the adoption to have a significant
adverse impact on the consolidated statements of operations and net loss per share.



In December 2004, the FASB issued FASB Staff Position No. FAS 109-2 (FAS 109-2), Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations
Act of 2004 (AJCA). The Company does not expect a material impact on its consolidated results of operations due to the AJCA or implementation of FAS 109-2.



|2. | Acquisitions:
|-- | -------------



The transactions below were recorded using the purchase method of accounting and the operating results of these acquisitions have been included in the
Companys results of operations since the date the acquisitions took place. The purchase prices have been allocated to assets acquired and liabilities assumed based on their fair values on the acquisition dates.



Net Nanny



On April 22, 2004, the Company acquired the business and certain assets of
Net Nanny, a division of Bionet Systems LLC, a privately held company, for $850,000 in cash, 1,972,387 shares of common stock, valued at $4.2 million and $27,000 of costs related to completing the transaction. Net Nanny is a desktop-based product,
which provides online parental control and content filtering of search results.



The common stock issued was valued at $2.15 per share in accordance with EITF Issue No. 99-12, Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business
Combination, using the average of the closing prices of the Companys common stock for the two days prior to and including April 22, 2004, which was prior to the announcement date of April 29, 2004.



Purchased technology and other intangible assets acquired are being amortized
over their estimated useful lives of two to six years. The consolidated financial statements include the operating results of Net Nanny from the date of purchase. Pro forma results of operations have not been presented because the effect of this
acquisition was not material to the results of prior periods presented.



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The following table summarizes the purchase price allocation. These amounts were determined through
established valuation techniques in the technology industry (in thousands):



|                                     |  |   |      
|------------------------------------ |  | - | -----
|Accounts receivable, net of reserves |  | $ | 171  
|Inventory                            |  |   | 34   
|Purchased technology                 |  |   | 510  
|Goodwill                             |  |   | 3,490
|Other intangible assets              |  |   | 940  
|                                     |  |   |      
|Total assets acquired                |  |   | 5,145
|Less: current liability assumed      |  |   | 34   
|                                     |  |   |      
|Net assets acquired                  |  | $ | 5,111
|                                     |  |   |      



Furl.net



During the third quarter of 2004, the Company acquired
the assets of Furl.net, which consisted primarily of intangible assets related to technology, customer lists, trade name and employees. The asset acquisition did not have a significant impact on total assets of the Company.



|3. | Goodwill and Intangible Assets
|-- | ------------------------------



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



|                              |  |              |        |   |                  |   |        |  
|----------------------------- |  | ------------ | ------ | - | ---------------- | - | ------ | -
|                              |  | June 30,2005 |        |   | December 31,2004 |  
|Goodwill                      |  | $            | 14,422 |   |                  | $ | 14,422 |  
|                              |  |              |        |   |                  |   |        |  
|Intangible assets:            |  |              |        |   |                  |   |        |  
|Purchased technology          |  | $            | 9,951  |   |                  | $ | 9,951  |  
|Less accumulated amortization |  |              | (5,466 | ) |                  |   | (4,614 | )
|                              |  |              |        |   |                  |   |        |  
|Net purchased technology      |  |              | 4,485  |   |                  |   | 5,337  |  
|Trade names                   |  |              | 1,470  |   |                  |   | 1,470  |  
|Less accumulated amortization |  |              | (323   | ) |                  |   | (167   | )
|                              |  |              |        |   |                  |   |        |  
|Net trade names               |  |              | 1,147  |   |                  |   | 1,303  |  
|Other intangibles             |  |              | 1,921  |   |                  |   | 1,921  |  
|Less accumulated amortization |  |              | (1,405 | ) |                  |   | (1,197 | )
|                              |  |              |        |   |                  |   |        |  
|Net other intangibles         |  |              | 516    |   |                  |   | 724    |  
|                              |  |              |        |   |                  |   |        |  
|Intangible assets, net        |  | $            | 6,148  |   |                  | $ | 7,364  |  
|                              |  |              |        |   |                  |   |        |  



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Intangible asset amortization expense was $0.6 million and $1.2 million for the three and six months
ended June 30, 2005, respectively, and $0.4 million and $0.8 million for the three and six months ended June 30, 2004, respectively, and is included in cost of revenue and product development costs.



Estimated future intangible amortization expense is as follows (in
thousands):



|                                |  |                                                 |      
|------------------------------- |  | ----------------------------------------------- | -----
|Year                            |  | Estimated Remaining Amortization of Intangibles
|Six months ending December 31,  |  |                                                 |      
|2005                            |  | $                                               | 1,214
|Fiscal year ending December 31, |  |                                                 |      
|2006                            |  |                                                 | 1,825
|2007                            |  |                                                 | 1,553
|2008                            |  |                                                 | 1,183
|2009                            |  |                                                 | 344  
|Thereafter                      |  |                                                 | 29   



|4. | Accrued Expenses and Other Current Liabilities:
|-- | -----------------------------------------------



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



|                                           |  |              |       |                  |   |      
|------------------------------------------ |  | ------------ | ----- | ---------------- | - | -----
|                                           |  | June 30,2005 |       | December 31,2004
|Accrued compensation and related expenses  |  | $            | 1,656 |                  | $ | 1,426
|Accrued distribution and partner costs     |  |              | 1,959 |                  |   | 3,428
|Current portion of restructuring liability |  |              | 1,505 |                  |   | 1,187
|Other                                      |  |              | 1,711 |                  |   | 1,991
|                                           |  |              |       |                  |   |      
|                                           |  | $            | 6,831 |                  | $ | 8,032
|                                           |  |              |       |                  |   |      



|5. | Commitments and Contingencies
|-- | -----------------------------



Operating Leases



The Company leases office space under non-terminable operating leases that expire at various dates through 2009.



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Future minimum payments under all operating leases, in total and net of minimum sublease income, at June
30, 2005 are as follows (in thousands):



|                      |  |                 |        |                                        |   |       
|--------------------- |  | --------------- | ------ | -------------------------------------- | - | ------
|                      |  | OperatingLeases |        | Operating Leases,Net ofSublease Income
|Year:                 |  |                 |        |                                        |   |       
|2005 remaining amount |  | $               | 2,294  |                                        | $ | 2,045 
|2006                  |  |                 | 4,616  |                                        |   | 4,547 
|2007                  |  |                 | 4,684  |                                        |   | 4,684 
|2008                  |  |                 | 4,751  |                                        |   | 4,751 
|2009                  |  |                 | 4,412  |                                        |   | 4,412 
|                      |  |                 |        |                                        |   |       
|Total                 |  | $               | 20,757 |                                        | $ | 20,439
|                      |  |                 |        |                                        |   |       



The Company has outstanding Standby
Letters of Credit (SBLC) related to security of building leases and security for payroll processing of $2.0 million at June 30, 2005.



The above SBLC contain two financial covenants, the first requiring a minimum net worth of $20 million and the second requiring minimum liquid assets, as
defined by the SBLC, of $40 million. At June 30, 2005, the Company was in compliance with both 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 partners in connection with the sales or distribution of its products, indemnities to various
lessors in connection with facility leases for certain claims arising from such facility or lease, and indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware. Historically, we
have not incurred any losses or recorded any liabilities related to performance under these types of indemnities.



Legal Proceedings



In August 2004, Mario Cisneros and Michael Voight filed a private attorney general lawsuit on behalf of a proposed class in Superior Court in San
Francisco County, California. The complaint names thirteen search engines or web publishers as defendants (including the Company) and alleges unfair business practices, unlawful business practices and other causes of action in connection with the
display of advertisements from internet gambling companies. The complaint seeks restitution, unspecified compensatory damages, declaratory and injunctive relief, and attorneys fees. Plaintiffs filed a motion for preliminary injunction and
served discovery requests, and the Company has responded to the complaint and filed a motion to strike certain allegations, which the court denied in part and granted in part. The court also allowed certain discovery to proceed with respect to
plaintiffs motion for preliminary injunction. Recently the court ordered an October 2005 trial on an issue in the case. At this point in time, the Company does not have sufficient information to assess the validity of the complaint or the
amount of potential damages.



In February 2005, Lanes
Gifts and Collectibles, L.L.C. and U.S. Citizens for Fair Credit Card Terms, Inc., filed a lawsuit on behalf of a proposed nationwide class of similarly situated persons in Circuit Court in Miller County, Arkansas. Subsequently, plaintiffs filed
first and second amended complaints adding additional plaintiffs. The Company was served with the second amended complaint in March 2005, which names eleven search engines or web publishers as defendants (including the Company)



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and alleges breach of contract, unjust enrichment, civil conspiracy and other causes of action in connection with the sale of clicks not generated by actual
consumer click-throughs. The complaint seeks monetary damages, restitution, prejudgment interest, attorneys fees and other remedies.The case was removed to United States District Court in Arkansas in March 2005. Plaintiffs subsequently
filed a motion for remand, which was recently granted. 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.
At this point in time, the Company does not have sufficient information to assess the validity of the complaint or the amount of potential damages.



The Company is also 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 the Companys consolidated results of operations, cash flows or financial position.
However, an unfavorable resolution of a matter could, depending on its amount and timing, materially affect the Companys 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.



JV Funding



Pursuant to the settlement agreement with British Telecommunications (BT) for the dissolution of the joint venture, LookSmart and BT are
jointly liable for the costs incurred to shut down operations of the joint venture. The Company does not expect to incur significant additional expenses to shut down the joint venture.



|6. | Net Loss Per Share:
|-- | -------------------



In accordance with the requirements of SFAS No. 128, a reconciliation of the numerator and denominator of basic and diluted loss per share is provided as
follows (in thousands, except per share amounts):



|                                             |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|-------------------------------------------- |  | -------------------------- | ------- | - | ------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                             |  | Three Months EndedJune 30, |         |   | Six Months EndedJune 30, |  
|                                             |  | 2005                       |         |   | 2004                     |   |         | 2005 |  |   | 2004    |  
|Numerator  basic and diluted:               |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Net loss                                     |  | $                          | (5,416  | ) |                          | $ | (1,237  | )    |  | $ | (9,756  | ) |  | $ | (8,362  | )
|                                             |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Denominator                                  |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Weighted average common shares outstanding:  |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Shares used to compute basic and diluted EPS |  |                            | 113,784 |   |                          |   | 111,235 |      |  |   | 113,761 |   |  |   | 109,716 |  
|                                             |  |                            |         |   |                          |   |         |      |  |   |         |   |  |   |         |  
|Net loss per basic and diluted share         |  | $                          | (0.05   | ) |                          | $ | (0.01   | )    |  | $ | (0.09   | ) |  | $ | (0.08   | )



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Options and warrants to purchase common stock are not included in the diluted loss per share calculations
if their effect is antidilutive. The antidilutive securities include potential common stock relating to stock options and warrants as follows (in thousands):



|                          |  |                             |  |                           |  |       |  |      
|------------------------- |  | --------------------------- |  | ------------------------- |  | ----- |  | -----
|                          |  | Three Months Ended June 30, |  | Six Months Ended June 30,
|                          |  | 2005                        |  | 2004                      |  | 2005  |  | 2004 
|Options                   |  | 14,075                      |  | 1,364                     |  | 9,185 |  | 1,832
|Warrants                  |  | 79                          |  | 45                        |  | 59    |  | 50   
|                          |  |                             |  |                           |  |       |  |      
|Total antidilutive shares |  | 14,154                      |  | 1,409                     |  | 9,244 |  | 1,882
|                          |  |                             |  |                           |  |       |  |      



|7. | Related Party Transactions:
|-- | ---------------------------



In 2002, the Company loaned Dianne Dubois, the Companys former Chief Financial Officer, $0.3 million. The loan was interest-free and subject to
forgiveness ratably over a period of four years, subject to certain performance measures being met. In addition, the Company had agreed to pay taxes due related to forgiveness of the loan and imputed interest.



The amount of imputed interest and tax adjustments charged to operations were
$6,000 and $12,000, respectively, for the three and six months ended June 30, 2004. Due to the resignation of the Chief Financial Officer in 2003, the outstanding balance of $0.2 million was repaid in August 2004.



The Company has a related-party receivable from the BT LookSmart joint
venture. In 2004, the Company recorded a valuation adjustment to the net receivable from the joint venture of $0.1 million based on revised estimates of net realizable value. The remaining investment balance at June 30, 2005 is $0.3 million, which
reflects the estimated value upon final liquidation of the joint venture.



|8. | Restructuring Charges
|-- | ---------------------



Employee Severance Costs.In November 2003, the Company implemented a restructuring plan to eliminate 77 positions in the United States due to the
loss of the ongoing relationship with Microsoft. In 2003, severance charges associated with the reduction in force were $0.8 million. In the first and second quarters of 2004, the Company eliminated an additional 43 positions in the United States,
which included a reduction in the Companys sales force of 11 positions, a reduction in the Companys general and administrative departments of 5 positions, a reduction in the Companys product development department of 14 positions
and a reduction in the Companys editorial team of 13 positions. This reduction resulted in $0.5 million, $0.4 million and $0.1 million restructuring charges recognized in the first, second and third quarters of 2004, respectively. These costs
are classified as restructuring charges on the condensed consolidated Statement of Operations, and are included in Operating Expenses. All severance costs were paid by the Company as of December 31, 2004.



Lease restructuring costs.In connection with the restructuring
activities noted above, the Company closed certain leased facilities and incurred lease restructuring costs related to closing these facilities of $3.2 million in the fourth quarter of 2003, and costs related to closing of further redundant leased
facilities of $3.2 million in the first quarter of 2004. These costs are classified as restructuring charges on the condensed consolidated Statement of Operations, and are included in Operating Expenses.



As of December 31, 2004, the restructuring liability was $5.7 million. Of
this amount, $1.3 million was included in other current portion of long-term liabilities and $4.4 million was included in other long-term liabilities on the condensed consolidated Balance Sheet.



The Company has had limited success in subleasing the unused space since the
establishment of the restructuring reserve and has modified the original estimates in the second quarter of 2005. This resulted in additional restructuring charges of $1.9 million, reflecting the reduced probability of subleasing the available
space.



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As of June 30, 2005, the lease restructuring liability was $6.7 million. Of this amount, $1.5 million was
included in other current portion of long-term liabilities and $5.2 million was included in other long-term liabilities on the condensed consolidated Balance Sheet.



The Company does not currently expect to incur significant further restructuring charges related to closing redundant leased
facilities during the remainder of 2005. However, if available sublease rates change significantly from the assumptions used, the actual costs related to these facilities could exceed estimated accrued facility costs and may require further
adjustment to the original estimates.



A reconciliation of the
liability for the lease restructuring costs at December 31, 2004 to the liability for the three months ended June 30, 2005 is as follows (in thousands):



|                                          |  |                           |       |  
|----------------------------------------- |  | ------------------------- | ----- | -
|                                          |  | Lease Restructuring Costs |      
|Balance at December 31, 2004              |  | $                         | 5,631 |  
|Reclassification of deferred rent         |  |                           | (184  | )
|Amortization of lease restructuring costs |  |                           | (657  | )
|Adjustment                                |  |                           | 1,903 |  
|                                          |  |                           |       |  
|Balance at June 30, 2005                  |  | $                         | 6,693 |  
|                                          |  |                           |       |  



|9. | Gain from Discontinued Operations
|-- | ---------------------------------



In January 2004, the Company agreed to sell certain assets of its Australian subsidiary and related intellectual property rights to a subsidiary of
Telstra Corporation Limited for the sum of approximately $0.7 million. In March 2004, the Company agreed to sell certain the assets of its Japanese subsidiary and related intellectual property rights to Value Commerce for the sum of approximately
$0.7 million. In March 2004, the Company agreed to sell certain assets of its United Kingdom subsidiary and related intellectual property rights to Crystal for the sum of approximately $0.1 million. The gain on disposal of these operations of $1.0
million, net of $0.4 million for transitional expenses, was recorded in the second quarter of 2004.



Revenue and pretax net income (loss) from the discontinued international operations (excluding gain on disposal), previously included in the listings
segment of the business, reported in discontinued operations were as follows (in thousands):



|                                             |  |                             |    |                           |   |       |  |      |     |  |   |       |  
|-------------------------------------------- |  | --------------------------- | -- | ------------------------- | - | ----- |  | ---- | --- |  | - | ----- | -
|                                             |  | Three Months Ended June 30, |    | Six Months Ended June 30, |  
|                                             |  | 2005                        |    | 2004                      |   | 2005  |  | 2004 |    
|Revenue                                      |  | $                           |   |                           | $ | 2,126 |  | $    |    |  | $ | 6,036 |  
|                                             |  |                             |    |                           |   |       |  |      |     |  |   |       |  
|Pretax net loss (excluding gain on disposal) |  |                             |   |                           |   | 17    |  |      |    |  |   | (439  | )
|Tax benefit                                  |  |                             |   |                           |   |      |  |      | 67  |  |   |      |  
|Gain on disposal                             |  |                             | 28 |                           |   | 1,023 |  |      | 43  |  |   | 1,023 |  
|                                             |  |                             |    |                           |   |       |  |      |     |  |   |       |  
|Net gain from discontinued operations        |  | $                           | 28 |                           | $ | 1,040 |  | $    | 110 |  | $ | 584   |  



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##### Table of Contents

|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------



The following discussion should be read in conjunction with the 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. These forward-looking statements
include without limitation statements about our future operating results and financial performance, including mix of revenue streams, ability to control and/or reduce operating expenses and anticipated gross margins; our business and our business
outlook, including the development and execution of new products, services, business initiatives and strategies and demand for our products and services; our plans to maintain and/or expand our network of distribution partners and our advertiser
base; our new product plans, including our continued entry into, and performance in, the vertical search market; and our expectations regarding our ability to reduce low-converting traffic or detect click fraud in our network;
anticipated levels of restructuring charges; the impact of legislative developments on the Company; general outlook of our business and industry; competitive position; stock compensation and adequate liquidity to fund our operations and meet our
other cash requirements. All forward-looking statements are based on current expectations, estimates, beliefs, assumptions, goals and objectives, are subject to numerous known and unknown risks, uncertainties and other factors and are not guarantees
of future performance or events. Actual results may differ materially from those anticipated in the forward-looking statements due to various risks, uncertainties and other factors such as, without limitation, our ability to maintain net
profitability in future quarters, our ability to preserve our expertise in search product development, our ability to maintain, expand and diversify our network of distribution partners, in the face of vigorous product-based and price-based
competition for their business, our ability to integrate our acquired businesses and to harvest from them significant gains in proprietary traffic, our ability to maintain traffic volumes in light of changes in the composition of our distribution
network, our ability to improve our match rate, average CPC or other advertiser metrics, and all other risks described below in the section entitled Risk Factors Affecting Operating Results and elsewhere in this report. All
forward-looking statements reflect the current belief of the Company as of the date hereof, and we expressly disclaim any obligation to update any forward-looking statements.



BUSINESS OVERVIEW



LookSmart is a provider of technology, content and tools for publishers, search results for consumers, as well as a provider of marketing products for
advertisers who want to be included in relevant search results on either LookSmart sites or on our distribution partners sites.



We distribute our search results across a distribution network by partnering with Internet portals, ISPs, search engines and media companies and
running on LookSmart-owned sites. These companies have increasingly recognized the valuable nature of search services for their web sites. We offer distribution partners a search solution with two important benefits. First, our search solution
provides highly relevant search results for their users, which can help to maintain the users satisfaction and increase repeat visits of those users. Second, we share with our distribution partners a portion of the listings revenues that we
generate from clicks on paid listings in those search results.



CRITICAL ACCOUNTING POLICIES



The financial
condition and results of operations of the Company are based upon certain critical accounting policies, which include estimates, assumptions, and judgments on the part of management. The Company bases its estimates on various factors and information
which may include, but 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. Actual results could differ from those estimates. The
following discussion highlights those policies and the underlying estimates and assumptions, which management considers critical to an understanding of the financial information in this report.



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Revenue Recognition. Revenues associated with listings products, including LookListings and
affiliate commissions, are generally recognized once collectibility is established, delivery of services has occurred, all performance obligations have been satisfied, and no refund obligations exist.



Listings revenue generated from our LookListings platform is primarily
composed of per-click fees that we charge customers. The per-click fee charged for inclusion-targeted listings is set with a customer when the account is established. The per-click fee charged for keyword targeted listings is calculated based on the
results of online bidding on keywords, up to a maximum cost per keyword set by the customer.



The Company provides a reserve against revenue for estimated credits resulting from sales adjustments and returns in the event of product returns. The amount of this reserve is evaluated quarterly based upon
historical trends.



Allowance for Doubtful Accounts.
Determination of collectibility of payments requires significant judgment on the part of management and includes performing initial and ongoing credit evaluations of customers. The Company maintains an allowance for doubtful accounts for estimated
losses resulting from the failure of our customers to make required payments. This valuation allowance is reviewed periodically based on factors including the application of historical collection rates to current receivables. The Company will record
a reduction of its general allowance for doubtful accounts if there is a significant improvement in collection rates or economic conditions are more favorable than the Company has anticipated. Additional allowances for doubtful accounts may be
required if there is deterioration in past due balances, if economic conditions are less favorable than the Company has 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 No. 142, Goodwill and Other Intangible Assets,
the Company periodically reassesses 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 which significantly changes the Companys business. 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. LookSmart regularly reviews its deferred tax
assets for recoverability and establishes 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.



Internal Use Software Development Costs. The Company accounts 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, the Company has capitalized the payroll and payroll-related costs of employees who devote time to the development of internal-use computer software.



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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.



Restructuring Charges



We have recorded a restructuring reserve related to closing certain leased facilities in accordance with SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal of Activities. Managements judgment is required in estimating when the redundant facilities will be subleased and at what rate they will be subleased.



RESULTS OF OPERATIONS



Overview of the Three and Six Months Ended June 30, 2005



During the second quarter of 2005, we continued to focus on three primary
operating priorities:



| |  |  | Improving our traffic conversion standards. We continued excising traffic sources from our distribution network that do not conform to quality standards of our
advertisers. In addition, we introduced run-of-site products offering unused advertisement space at a discounted rate per click. As a result, our match rate, or the rate at which paid listings are matched against search queries, grew by 7%,
excluding our run-of-site products, from first quarter of 2005 to second quarter of 2005. The match rate is a key driver for our business because a higher match rate means a greater number of paid listings are competing for position in the sponsored
links section of search results pages. We expect to continue major traffic optimization efforts in the third quarter of 2005.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Developing syndicated solutions for publishers. We continued focusing on what our partners need. During the second quarter, we launched our LookSmart SearchWISE
solution for publishers designed to improve the users search experience and increase usage and visits. We also rolled out LookSmart AdWISE allowing publishers to own the advertiser relationships and maximize yield. These offerings include a
white-labeled advertising management center, search of a publishers own archived content, and a tailored version of our Furl online book marking system for publishers. As a result of these efforts, we signed technology-licensing agreements
with a major publisher and a major media company. Implementation of these projects is expected to begin in the third quarter of 2005.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Focusing on our vertical search business. We redefined our approach strategically focusing on our vertical search business. We are leveraging our core expertise in
directories, database structures, algorithmic searches and communities by integrating Furl and other LookSmart technologies to provide a compelling environment for both customers and advertisers. We expect to launch numerous vertical search sites in
addition to ten sites launched in the first half of 2005.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Revenues



|         |  |                            |        |                    |   |        |                          |     |                    |  |   |        |  |   |        |  |     |   
|-------- |  | -------------------------- | ------ | ------------------ | - | ------ | ------------------------ | --- | ------------------ |  | - | ------ |  | - | ------ |  | --- | --
|         |  | Three Months EndedJune 30, |        | %Change2004 to2005 |   |        | Six Months EndedJune 30, |     | %Change2004 to2005 | 
|(000s)  |  | 2005                       |        | 2004               |   |        | 2005                     |     | 2004               | 
|Revenues |  | $                          | 10,225 |                    | $ | 19,131 |                          | (47 | )%                 |  | $ | 22,226 |  | $ | 42,981 |  | (48 | )%



Revenues in the three
and six months ended June 30, 2005 decreased compared to the three and six months ended June 30, 2004 primarily due to a proactively managed reduction of our distribution network, a decline in the number of customers and the winding down of our
relationship with Microsoft, which winding down began in January of 2004. We derived 2% and 22% of our revenues in the first half of 2005 and the first half of 2004, respectively, from our relationship with Microsoft.



Total paid clicks were 80 million and 164 million in the three and six months
ended June 30, 2005, respectively, compared to 119 million and 264 million in the three and six months ended June 30, 2004, respectively. Average revenue per click, excluding discounted, run-of-site products, decreased to $0.15 per click and $0.14
per click in the three and six months ended June 30, 2005, respectively, compared to $0.16 in the three and six months ended June 30, 2004. This decline was primarily the result of a reduction in our match rate in certain segments of search due to
the decline in the number of advertisers and distribution partners.



We began recording revenue from the sale of advertising on our vertical search products in the second quarter of 2004. This revenue was less than 10% of total revenue in the three and six months ended June 30, 2005.



Revenue is expected to decline in the third quarter of 2005 compared to the
second quarter of 2005 as we continue optimizing our distribution network and reducing the number of partners.



Cost of Revenues



|                          |  |                            |       |   |                    |   |        |                          |      |     |                    |      |   |        |   |  |   |        |   |  |     |   
|------------------------- |  | -------------------------- | ----- | - | ------------------ | - | ------ | ------------------------ | ---- | --- | ------------------ | ---- | - | ------ | - |  | - | ------ | - |  | --- | --
|                          |  | Three Months EndedJune 30, |       |   | %Change2004 to2005 |   |        | Six Months EndedJune 30, |      |     | %Change2004 to2005 |     
|(000s)                   |  | 2005                       |       |   | 2004               |   |        |                          | 2005 |     |                    | 2004 |   |       
|Traffic acquisition costs |  | $                          | 5,224 |   |                    | $ | 9,699  |                          |      | (46 | )%                 |      | $ | 11,888 |   |  | $ | 22,115 |   |  | (46 | )%
|Percentage of revenues    |  |                            | 51    | % |                    |   | 51     | %                        |      |     |                    |      |   | 53     | % |  |   | 51     | % |  |     |   
|Other costs               |  |                            | 1,396 |   |                    |   | 1,304  |                          |      | 7   | %                  |      |   | 3,024  |   |  |   | 2,711  |   |  | 12  | % 
|                          |  |                            |       |   |                    |   |        |                          |      |     |                    |      |   |        |   |  |   |        |   |  |     |   
|Total cost of revenues    |  | $                          | 6,620 |   |                    | $ | 11,003 |                          |      | (40 | )%                 |      | $ | 14,912 |   |  | $ | 24,826 |   |  | (40 | )%
|Percentage of revenues    |  |                            | 65    | % |                    |   | 58     | %                        |      |     |                    |      |   | 67     | % |  |   | 58     | % |  |     |   



Traffic acquisition
costs, the costs paid to our distribution partners, decreased during the three and six months ended June 30, 2005 compared to the three and six months ended June 30, 2004 primarily due to the decline in revenue. The slight increase in traffic
acquisition costs as a percent of revenue in first half of 2005 compared to the first half of 2004 reflects our continued efforts to improve our traffic quality and optimize traffic flow from our partners. These efforts included the removal of
low-converting traffic from our distribution network in the first half of 2005.



We expect traffic acquisition costs as a percent of listings revenue to increase to 56-59% in the third quarter of 2005 due to continuous traffic optimization efforts.



Other costs of revenue consist of connectivity costs, personnel costs of our
sales operations employees, including stock-based compensation, equipment depreciation, expenses relating to hosting advertising operations, commissions paid to advertising agencies and amortization of intangible assets. These costs



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increased during the three and six months ended June 30, 2005 compared to the three and six months ended June 30, 2004 due to additional line rental charges
and cost of consumer product traffic.



Operating Expenses



We are in the process of evaluating the option
expensing requirements of SFAS 123R and expect the adoption to significantly increase operating expenses in 2006.



Sales and Marketing. Sales and marketing expenses include salaries, commissions, stock-based compensation and other costs of employment for the
Companys sales force, sales administration and customer service staff, overhead, facilities, allocation of depreciation and the provision for doubtful trade receivables. Sales and marketing expenses also include the costs of advertising, trade
shows and public relations activities.



Sales and marketing
expenses were as follows (dollar figures are in thousands):



|                                               |  |                             |       |   |                           |   |       |      |  |   |       |   |  |   |       |  
|---------------------------------------------- |  | --------------------------- | ----- | - | ------------------------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                               |  | Three Months Ended June 30, |       |   | Six Months Ended June 30, |  
|                                               |  | 2005                        |       |   | 2004                      |   |       | 2005 |  |   | 2004  |  
|Stock compensation related to variable options |  |                             |      |   |                           |   | (8    | )    |  |   | (17   | ) |  |   | (2    | )
|Other sales and marketing expenses             |  |                             | 1,714 |   |                           |   | 1,802 |      |  |   | 3,366 |   |  |   | 4,551 |  
|                                               |  |                             |       |   |                           |   |       |      |  |   |       |   |  |   |       |  
|Sales and marketing                            |  | $                           | 1,714 |   |                           | $ | 1,794 |      |  | $ | 3,349 |   |  | $ | 4,549 |  
|Percentage of total revenues                   |  |                             | 17    | % |                           |   | 9     | %    |  |   | 15    | % |  |   | 11    | %



Stock compensation
related to variable options is the result of repriced stock options. Stock compensation related to variable options is based on the Companys stock price at the end of each quarter and will continue to fluctuate as the Companys stock
price fluctuates.



Other sales and marketing expenses decreased
primarily due to a reduction in salaries and benefits by of $0.2 million in the three months ended June 30, 2005 compared to the three months ended June 30, 2004 and $1.3 million in the six months ended June 30, 2005 compared to the six months ended
June 30, 2004. The decrease in salaries and benefits reflects a 30% reduction in headcount as a result of the Companys restructuring activities in 2004 and lower revenue base in 2005.



Product Development.Product development costs include all costs
related to the development and engineering of new products and continued development of our search databases and additional features for our customer account management platform. These costs include salaries and associated costs of employment,
including stock-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. Product development expenses were as follows
(dollar figures are in thousands):



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|                                               |  |                            |       |   |                          |   |       |      |  |   |       |   |  |   |        |  
|---------------------------------------------- |  | -------------------------- | ----- | - | ------------------------ | - | ----- | ---- |  | - | ----- | - |  | - | ------ | -
|                                               |  | Three Months EndedJune 30, |       |   | Six Months EndedJune 30, |  
|                                               |  | 2005                       |       |   | 2004                     |   |       | 2005 |  |   | 2004  |  
|Amortization of deferred stock compensation    |  |                            | 13    |   |                          |   | 20    |      |  |   | 27    |   |  |   | 43     |  
|Stock compensation related to variable options |  |                            |      |   |                          |   | (7    | )    |  |   | (38   | ) |  |   | 13     |  
|Capitalized software development costs         |  |                            | (181  | ) |                          |   | 506   |      |  |   | (307  | ) |  |   | 158    |  
|Other product development expenses             |  |                            | 4,500 |   |                          |   | 5,472 |      |  |   | 9,415 |   |  |   | 13,068 |  
|                                               |  |                            |       |   |                          |   |       |      |  |   |       |   |  |   |        |  
|Total product development expenses             |  | $                          | 4,332 |   |                          | $ | 5,991 |      |  | $ | 9,097 |   |  | $ | 13,282 |  
|Percentage of revenues                         |  |                            | 42    | % |                          |   | 31    | %    |  |   | 41    | % |  |   | 31     | %



Amortization of
deferred stock compensation relates to stock granted to employees at less than market value. Stock compensation related to variable options is the result of repriced stock options. Stock compensation related to variable options is based on the
Companys stock price at the end of each quarter and will continue to fluctuate as the Companys stock price fluctuates.



Capitalized software development costs include the costs to develop software for internal use, excluding costs associated with research and development,
training and testing. The decrease in the amount capitalized for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 was primarily related to a write off in the second quarter of $0.8 million in software previously
capitalized for projects that were cancelled in the second quarter of 2004 as they related to projects that were not aligned with our 2004 operating plan. The decrease in other product development expenses in the second quarter of 2005 compared to
the second quarter of 2004 was due primarily to a reduction in salaries and benefits of $0.5 million and facilities costs of $0.3 million due to the restructuring activities in early 2004 and overall cost reductions efforts.



The decrease in other product development expenses in the six months ended
June 30, 2005 compared to the six months ended June 30, 2004 was primarily due to a reduction in salaries and benefits of $2.8 million due to the restructuring activities and a headcount reduction of approximately 17%. We expect product development
expenses to increase slightly during the remainder of 2005.



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 stock-based compensation, overhead, facilities and allocation of depreciation. General and administrative expenses also include legal, tax and accounting, consulting and professional service fees.



General and administrative expenses were as follows (dollar figures are in
thousands):



|                                               |  |                            |       |   |                          |   |       |      |  |   |       |   |  |   |       |  
|---------------------------------------------- |  | -------------------------- | ----- | - | ------------------------ | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                               |  | Three Months EndedJune 30, |       |   | Six Months EndedJune 30, |  
|                                               |  | 2005                       |       |   | 2004                     |   |       | 2005 |  |   | 2004  |  
|Stock compensation related to variable options |  |                            |      |   |                          |   |      |      |  |   | 13    |   |  |   |      |  
|Other general and administrative expenses      |  |                            | 1,539 |   |                          |   | 2,252 |      |  |   | 3,708 |   |  |   | 5,363 |  
|                                               |  |                            |       |   |                          |   |       |      |  |   |       |   |  |   |       |  
|Total general and administrative expenses      |  | $                          | 1,539 |   |                          | $ | 2,252 |      |  | $ | 3,721 |   |  | $ | 5,363 |  
|Percentage of total revenues                   |  |                            | 15    | % |                          |   | 12    | %    |  |   | 17    | % |  |   | 12    | %



Stock compensation
related to variable options is the result of repriced stock options. Stock compensation related to variable options is based on the Companys stock price at the end of each quarter and will continue to fluctuate as the Companys stock
price fluctuates.



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Other general and administrative expense decreased in the three months ended June 30, 2005 compared to
the three months ended June 30, 2004 primarily due to a decrease in professional services of $0.3 million and a decrease of insurance costs of $0.3 million. The decrease in expenses in the six months ended June 30, 2005 compared to June 30, 2004 was
due to a decrease in salaries and benefits of $0.6 million reflecting a 38% reduction in headcount and a decrease in international costs of $0.9 million. We expect other general and administrative expenses to increase during the remainder of 2005
compared to the first half of 2005 as we anticipate an increase in professional fees in the second half of 2005 compared to the first half of 2005 related to compliance with the Sarbanes-Oxley Act.



Restructuring Costs



Employee Severance Costs.In November 2003, we implemented a
restructuring plan to eliminate 77 positions in the United States due to the loss of the ongoing relationship with Microsoft. In 2003, severance charges associated with the reduction in force were $0.8 million. In the first and the second quarters
of 2004, we eliminated an additional 43 positions in the United States, which included a reduction in the Companys sales force of 11 positions, a reduction in our general and administrative departments of 5 positions, a reduction in our
product development department of 14 positions and a reduction in our editorial team of 13 positions. This reduction resulted in $0.5 million, $0.4 million and $0.1 million restructuring charges recognized in the first, second and third quarters of
2004, respectively. These costs are classified as restructuring charges on the condensed consolidated Statement of Operations, and are included in Operating Expenses. All severance costs were paid by the December 31, 2004.



Lease restructuring costs.In connection with the restructuring
activities noted above, we closed certain leased facilities and incurred lease restructuring costs related to closing these facilities of $3.2 million in the fourth quarter of 2003, and costs related to closing of further redundant leased facilities
of $3.2 million in the first quarter of 2004.



We have had
limited success in subleasing the unused space since the establishment of the restructuring reserve and accordingly modified the original estimates related to subleases in the second quarter of 2005. This resulted in additional restructuring charges
of $1.9 million, reflecting the reduced probability of subleasing the available space.



We do not currently expect to incur significant further restructuring charges related to closing redundant leased facilities during the remainder of 2005. However, if available sublease rates change significantly from
the assumptions used, the actual costs related to these facilities could exceed estimated accrued facility costs and may require further adjustment to the original estimates.



Non-Operating Income



Interest and Other Non-Operating income, net.Interest and other non-operating income increased by $0.8 million in the six months ended June 30,
2005 compared to the six months ended June 30, 2004. This was due to an increase in interest income on cash, cash equivalents and investments as a result of higher overall interest rates earned by our investment portfolio. Interest and other
non-operating income increased by $0.4 million in the three months ended June 30, 2005 compared to the three months ended June 30, 2004 due to the same factor.



Income Tax Expense



The Company did not incur any significant income tax expense in the three and six months ended June 30, 2005 and 2004 due to net loss incurred in these
periods.



The effective tax rate in the upcoming quarters and
for the year ending December 31, 2005 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.



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Gain from Discontinued Operations



In January 2004, we agreed to sell certain assets of our Australian subsidiary and related intellectual property rights to a
subsidiary of Telstra Corporation Limited for the sum of approximately $0.7 million. In March 2004, we agreed to sell certain assets of our Japanese subsidiary and related intellectual property rights to Value Commerce for the sum of approximately
$0.7 million. In March 2004, we agreed to sell certain assets of our United Kingdom subsidiary and related intellectual property rights to Crystal for the sum of approximately $0.1 million. The gain on disposal of the operations of $1.0 million, net
of $0.4 million for transitional expenses, was recorded in the second quarter of 2004.



Revenue and pretax net income (loss) from the discontinued international operations (excluding gain on disposal), previously included in the listings segment of the business, reported in discontinued operations were
as follows (in thousands):



|                                             |  |                            |    |                          |   |       |  |      |     |  |   |       |  
|-------------------------------------------- |  | -------------------------- | -- | ------------------------ | - | ----- |  | ---- | --- |  | - | ----- | -
|                                             |  | Three Months EndedJune 30, |    | Six Months EndedJune 30, |  
|                                             |  | 2005                       |    | 2004                     |   | 2005  |  | 2004 |    
|Revenue                                      |  | $                          |   |                          | $ | 2,126 |  | $    |    |  | $ | 6,036 |  
|                                             |  |                            |    |                          |   |       |  |      |     |  |   |       |  
|Pretax net loss (excluding gain on disposal) |  |                            |   |                          |   | 17    |  |      |    |  |   | (439  | )
|Tax benefit                                  |  |                            |   |                          |   |      |  |      | 67  |  |   |      |  
|Gain on disposal                             |  |                            | 28 |                          |   | 1,023 |  |      | 43  |  |   | 1,023 |  
|                                             |  |                            |    |                          |   |       |  |      |     |  |   |       |  
|Net gain from discontinued operations        |  | $                          | 28 |                          | $ | 1,040 |  | $    | 110 |  | $ | 584   |  



As we finalize the
liquidation process in our Australian subsidiary, we expect to record additional income related to the reversal of the cumulative translation adjustment of $0.5 million in 2005.



Liquidity and Capital Resources



Our primary source of cash is receipts from revenue. Another source of cash is proceeds from the exercise of employee stock options. The primary uses of
cash are payroll (salaries, bonuses and benefits), general operating expenses (office rent), payments to distribution partners related to cost of revenue and professional services related to audit costs. We ended the second quarter of 2005 with
$61.1 million in cash, cash equivalents, short-term investments and long-term investments, a decrease from $63.9 million at December 31, 2004. Our short-term and long-term investments decreased by $1.3 million from December 31, 2004 to June 30,
2005.



|                                            |      |                          |   |      |         |  
|------------------------------------------- | ---- | ------------------------ | - | ---- | ------- | -
|(000s)                                     |      | Six Months EndedJune 30, |  
|                                            | 2005 |                          |   | 2004 |        
|Cash flows used in operating activities     |      | (1,448                   | ) |      | (5,153  | )
|Cash flows used in investing activities     |      | (60                      | ) |      | (23,244 | )
|Cash flows provided by financing activities |      | 56                       |   |      | 3,507   |  



The termination and
winding down of the Companys distribution and licensing relationship with Microsoft significantly reduced the Companys revenue and cash from operating activities in the six months ended June 30, 2005 compared to the six months ended June
30, 2004. In order to minimize the impact of the termination of the Microsoft agreement on the Companys liquidity, the Company implemented a restructuring plan.



The decrease in cash used in operating activities in the first half of 2005 compared to the first half of 2004 was primarily
due to an increase in accounts payable of $2.0 million due to timing difference of payment cycles and a decrease in accounts receivable of $1.6 million due to a reduction of revenue. Collections of accounts receivable can impact our operating cash
flows. Management places significant



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emphasis on collection efforts and has assessed the allowance for doubtful accounts as of June 30, 2005 and has deemed it to be adequate.



Net cash used in investing activities in the first half of 2005 and the first
half of 2004 included purchases of investments of $5.8 million and $22.1 million, respectively, and purchases of equipment and capitalization of costs related to internally developed software of $1.2 million and $1.8 million, respectively. Cash used
in investing activities in the first half of 2004 also included the purchase of NetNanny, which used $0.9 million in cash in the first half of 2004 and was offset by proceeds from the sale of discontinued operations of $1.5 million. Cash provided by
investing activities in the first half of 2005 included proceeds from sale of investments of $5.0 million and maturities of investments of $1.9 million.



In the six months ended June 30, 2005 and 2004, net cash provided by financing activities was primarily due to proceeds from the exercise of employee
stock options of $0.1 and $3.6 million, respectively.



We
believe that our working capital will provide adequate liquidity to fund our operations and meet other cash requirements for at least the next 12 months. 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 assure you 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.



Off-Balance Sheet Arrangements



We do not have any off balance-sheet arrangements, 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 what we disclosed in our Annual Report on Form 10-K for fiscal 2004, we believe that there have been no significant changes in
contractual obligations or commercial commitments.



Operating Lease ObligationsOur operating lease obligations relate primarily to our San Francisco headquarters.



Capital Lease ObligationsWe have no material capital lease obligations.



Note ObligationWe have a note agreement to finance tenant improvements that bears interest at 9% per annum.



Purchase Obligations  Our purchase obligations
consist of commitments for both merchandise and services.



Guarantees Under Letters of Credit We have obtained standby letters of credit from time to time as security for certain liabilities. At June 30, 2005, we had outstanding letters of credit related to security of building leases
and security for payroll processing of $2.0 million.



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Indemnifications



In the normal course of business, we provide indemnifications of varying scope to customers and distribution partners against claims of intellectual
property infringement or other claims made by third parties arising from the use of our products. Historically, costs related to these indemnification provisions have not been significant and we are unable to estimate the maximum potential impact of
these indemnification provisions on our future results of operations.



As permitted under Delaware law, we have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was, serving, at our request, in such capacity. The maximum potential
amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that limits our exposure and enables us to recover a portion of any future amounts
paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal. Historically, we have not incurred significant costs related to performance under these types of indemnities.



Recently Issued Accounting Pronouncements



See Note 1 in the Notes to Condensed Consolidated Financial Statements.



RISK FACTORS AFFECTING OPERATING RESULTS



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



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



Listings accounted for more than 90% of our revenues in the six months ended June 30, 2005 and will likely account for substantially all of our revenues
in 2005. Our success will depend upon the extent to which advertisers choose to use and partners choose to distribute our listings products. Advertisers and partners may not adopt our listings products at projected rates, or changes in market
conditions may affect the adoption of our listings products. Because of our revenue concentration in the listings business, such shortfalls or changes could have a negative impact on our financial results. If we are unable to generate significant
additional revenues from our listings business or significantly reduce our operating costs, our results of operations, financial condition and/or liquidity will suffer.



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



In the first half of 2005, substantially all of our revenues came from search traffic on our distribution network. We may be unable to maintain key partners in our distribution network. Our distribution network is concentrated, with our
five largest network partners accounting for approximately 49% and 56% of our revenues in the three and six months ended June 30, 2005, respectively. If we lose any significant portion of our distribution network, we would need to find alternative
sources of high quality click traffic to replace the lost paid clicks. Although alternate sources of click traffic are currently available in the market, it may not be available at reasonable prices, it will likely be subject to competition from
various paid search providers, and it may be of lower quality. The search market is consolidating and there is fierce competition among search providers to sign agreements with traffic providers. We face the risk that we might be unable to negotiate
and sign agreements with high 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 revenues would be seriously harmed.



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



We had a net loss of $9.8 million in the six months ended June 30, 2005 and as of June 30, 2005 our accumulated deficit was $196 million. We may be unable
to achieve operating profitability in the foreseeable future and, if we regain operating profitability, we may be unable to maintain it. Our ability to achieve and maintain operating profitability will depend on our ability to generate additional
revenues and contain our expenses. In order to generate additional revenues, we will need to expand our network of distribution partners, expand our proprietary traffic sources, and expand our advertiser base. We may be unable to do so 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 partners, to invest in product development, marketing and search
technologies (exemplified by our renewed focus on our vertical search business), and enhance our search services. Because of the foregoing factors, and others outlined in this report, we may be unable to achieve operating 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, or rate at which paid listings are matched against search queries, due to various factors. In the first half of 2005, for example, our average revenue per click and average match rate decreased compared to the first half of 2004. 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, or for other reasons. If our revenue per click or average match rate fall 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 advertiser base; if our advertiser base and average advertiser spend continues to fall, 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 LookListings. If this occurs, it is likely that our average revenue per click and average match rate may decline, we may be unable to meet our financial guidance,
and our stock price would likely suffer.



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



Click fraud is an ongoing problem for the Internet advertising industry, and we are exposed to the risk of fraudulent clicks on our paid listings. Click
fraud occurs when a person or robotic software clicks on a paid listing for some reason other than to view the underlying content. We invest significant time and resources in preventing, detecting and eliminating suspicious 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 fraudulent clicks from our search network. We are subject to advertiser complaints
and litigation regarding click fraud, and advertisers may continue to lodge complaints due to the perception that click fraud has occurred. 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 fraud detection systems are insufficient, or if we find new evidence of past fraudulent clicks, we may have to issue credits or refunds retroactively to our advertisers, yet we may still have
to pay



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revenue share to our network partners. This would negatively affect our profitability and hurt our brand. If fraudulent clicks are not detected and removed
from our search network, the affected advertisers may experience a reduced return on their investment in our listings because the fraudulent clicks will not lead to actual sales for the advertisers. This could lead the advertisers to become
dissatisfied with our listings, which could lead to loss of advertisers and revenue and could materially and adversely affect our financial results.



Our vertical search sites and syndicated publisher solutions may not be successful or gain customer and user acceptance, and there are risks associated with
introducing new products and services.



To maintain and
grow our revenue, part of our strategy is to introduce syndicated solutions for publishers and vertical search sites. 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. We may not gain enough of an audience for our vertical search sites to generate any, or sufficient, revenue to justify our efforts, or we may gain a sufficient audience but be unable to gain advertiser
acceptance of our vertical search sites. 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. If we are unable to develop or introduce new and enhanced vertical search sites in a timely manner, we may lose existing customers to our competitors and
fail to attract new customers, which may adversely affect our performance and results of operations.



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



The Internet search industry is rapidly evolving and very turbulent, and we will need to continue developing new products
and services (such as the ability to serve advertisements contextually), adapt to new business environments and competition, and generate traffic to our consumer web properties in order to maintain and grow revenue and reach our profitability goals.
New search and advertising technologies could emerge that make our services comparatively less useful or new business methods could otherwise emerge that divert Web traffic away from our search network and consumer web properties. Competition from
other web businesses may prevent us from attracting substantial traffic to our services. Also, we may inaccurately predict the direction of search technologies or the advertising market, which could lead us to make investments in technologies and
products that do not generate sufficient returns. 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
forecast our results accurately, particularly over longer periods, and might cause our profitability to decline significantly. We face the risk that we may be unable to adapt to new developments in the search industry, or that our new consumer
products and services may not be broadly adopted by customers, in which case we would eventually need to obtain additional financing or cease operations.



Our securities may be delisted



The Nasdaq National Market requires us to satisfy certain continued listing requirements, including maintaining a minimum closing bid price for our common
stock of at least $1.00 per share. On April 15, 2005 Nasdaq sent us a letter stating that for the prior thirty trading days, our stock price had closed below $1.00. We have until October 12, 2005 to regain compliance with the Nasdaq listing
requirements by having our stock price close at or above $1.00 for a minimum of ten consecutive business days, or such longer period of time as required by Nasdaq. If we are unable to regain compliance and are ineligible for an extension of time to
retain compliance, our securities will be delisted from the Nasdaq National Market. We may be ineligible at that point in time for an extension of time to regain compliance or to shift our listing to the Nasdaq Small Cap Market. If delisting occurs,
our securities will not enjoy the same liquidity as shares that are traded on the Nasdaq National Market or a national U.S. securities exchange and investors may find that it is more difficult to obtain accurate and timely quotations. As a result,
the price of



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our securities would likely decline. If we fail to meet Australian Stock Exchange listing requirements, we may be delisted from that exchange as well.



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, including our search service, whether caused by computer viruses, software failure, power interruptions, unauthorized 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.



Our success depends on our ability to attract and retain key personnel; if we were unable to continue 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 software development, technical, sales, and management personnel. 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. 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 to crawl the web and index web pages, create and edit listings, compile and distribute our search results, track paid clicks, and detect click fraud. 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 web site or the web sites of our distribution partners:



| |  |  | customization of our search results for distribution to particular partners,
| | - |  | ----------------------------------------------------------------------------



| |  |  | substantial increases in the number of search queries to our database,
| | - |  | ----------------------------------------------------------------------



| |  |  | substantial increases in the number of listings in our search databases, or
| | - |  | ---------------------------------------------------------------------------



| |  |  | the addition of new products, features or changes in our directory structure.
| | - |  | -----------------------------------------------------------------------------



If we fail to address these issues in a timely manner, we may lose the confidence of advertisers and partners, our revenues 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.



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:



| |  |  | changes in our distribution network, particularly the gain or loss of key distribution partners, or changes in the implementation of search results on partner web sites,
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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| |  |  | 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,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the effect of accounting for our headquarters office lease in San Francisco, which reflects our managements assumptions about the subleasing market,
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | systems downtime on our Advertiser Center, our web site or the web sites of our distribution partners, or
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | the effect of variable accounting for stock options, which requires that we book an operating expense in connection with some of our outstanding stock options at the end of each
quarter, depending on the closing price of our common stock on the last trading day of the quarter and the number of stock options subject to variable accounting.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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 business depends on Internet service
providers, and any failure or system downtime experienced by these companies could materially and adversely affect our revenues



Our users, partners and customers depend on ISPs, online service providers and other third parties for access to LookSmart search results. 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 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, 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.



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



As described in note 1 to the consolidated financial statements in this report, the Company is required to adopt SFAS 123R (accounting for stock options using the fair value method of accounting) starting January 1, 2006, which will likely
increase our compensation expenses related to stock options. The adoption of SFAS 123R will likely have a significant adverse impact on our results of operations and net loss per share.



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



Companies in the Internet, technology and media
industries own large numbers of patents, copyrights, trademarks and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. These claims might, for example, be made
for trademark, copyright or patent infringement, defamation, negligence, personal injury, breach of contract, unfair advertising, unfair competition, invasion of privacy or other claims. As we face increasing competition and expand the number of
websites that we publish, the possibility of intellectual property rights claims against us grows, and we cannot guarantee that our services do not infringe the intellectual property rights of others. Lawsuits are filed against us from time to time,
and we are currently subject to two purported class action lawsuits in connection with our listings services. In addition, we are obligated in some cases to indemnify our customers or 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 search services or
listings 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 revenues 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 face growing competitive pressures, which could materially and adversely affect our financial results



We compete in the relatively new and rapidly evolving paid search 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, including AOL Time Warner,
Ask Jeeves, FindWhat, Google (and its AdWords and Sprinks services), Microsofts MSN, and Yahoo! (and its Overture service). In the paid inclusion field, we compete for advertisers on the basis of the relevance of our search results, 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. Some of our competitors have larger distribution networks and proprietary
traffic bases, longer operating histories and greater brand recognition than we have.



Litigation, regulation, legislation or enforcement actions directed at or materially affecting the Internet advertising, search engine or website publishing industry 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 search engine industry may limit the delivery, appearance and content of our advertising 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 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 users and issued guidance on what disclosures are necessary to avoid misleading users 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, any of which could, if enacted, adversely affect our business. 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.



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



The stock market has experienced significant
price and volume fluctuations in recent years, and the stock prices of Internet companies have been extremely volatile. Because of our limited operating history and the operational changes required by the reduction of the Microsoft distribution
channel resulting from 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 decline, and you may not be able to sell your shares for a profit, as a result
of a number of factors including:



| |  |  | 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 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 participants in our pre-IPO equity financings or by owners of businesses we have acquired, or the
perception that such sales could occur,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the exchange by Chess Depository Interest (CDI) holders of CDIs for shares of common stock and resale of such shares in the Nasdaq National Market (as of August 2, 2005, the CDIs
registered for trading on the Australian Stock Exchange were exchangeable into an aggregate of approximately 11.3 million shares of common stock), or
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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, 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



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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 our 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,
| | - |  | --------------------------------------------------



| |  |  | 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.



We rely on insurance to mitigate some risks and, to the extent the cost of insurance increases or we are unable to maintain sufficient insurance to mitigate the risks, our operating results may be diminished



We purchase insurance to cover potential risks and liabilities. In the
current environment, insurance companies are increasingly specific about what they will and will not insure. It is possible that we may not be able to get enough insurance to meet our needs, may have to pay very high prices for the coverage we do
get or may not be able to acquire any insurance for certain types of business risk. This could leave us exposed to potential claims or unexpected events. If we were found liable for a significant claim in the future, our operating results could be
negatively impacted. Also, to the extent the cost of insurance increases, our operating results will be negatively affected.



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 search results, track paid clicks, and provide customer support would materially and adversely
affect our financial results.



Our acquisition of businesses and
technologies may be costly and time-consuming; acquisitions will likely 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 and expand our service offerings. 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 or record impairment of goodwill in connection with future acquisitions, which would adversely affect our operating results.



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We have acquired businesses and technologies in recent years, including the acquisition of certain assets
from BioNet Systems, LLC in the second quarter of 2004 and from 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. We license to end users certain software we acquired from BioNet Systems, LLC, but we may lack the
managerial and technical resources necessary to implement a successful software licensing business model in a timely manner. Unlicensed copying and use of such software in the United Sates and abroad will represent a loss of revenue to us.
Furthermore, end users may not license our products at projected rates.



If
we become subject to employment claims, we could incur liability for damages and incur substantial costs in defending ourselves



Companies in our industry whose employees accept positions with competitors frequently claim that these competitors have engaged in unfair hiring
practices or that the employment of these persons would involve the disclosure or use of trade secrets. These claims could prevent us from hiring personnel or cause us to incur liability for damages. We may also be sued in connection with our
restructuring and workforce reductions by employees claiming wrongful termination or similar causes of action. We could also incur substantial costs in defending ourselves or our employees against these claims, regardless of their merits. Defending
ourselves from these claims could also divert the attention of our management away from our operations.



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 is considering new legislation 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 users 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 search engine places 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 users 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 users 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 revenues.



We
and some of our partners or advertisers retain information about our users. If others were able to penetrate the network security of these user databases and access or misappropriate this information, we and our 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.



We may incur unforeseen expenses and liabilities in connection with the dissolution of BT LookSmart and closure of our international
operations



We are still in the process of dissolving our
joint venture, BT LookSmart, and our other international operations. Withdrawal from foreign markets and closure or dissolution of foreign operations may be more costly than we anticipated, possibly involving employment-related litigation or tax
audits. If we incur costs



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in excess of the amounts we forecasted in connection with these activities, our financial results would be materially and adversely affected.



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.



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 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------



Interest Rate Risk. The Companys exposure to market risk for interest rate changes relates primarily to its short-term and long-term
investments. The Company had no derivative financial instruments as of June 30, 2005 or December 31, 2004. The Company invests its 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. If market interest rates were to increase or decrease immediately and uniformly by 10% from levels as of June 30, 2005 or December 31, 2004, the increase or decline in the fair value of the investment portfolio would not be material to
our results of operations.



Foreign Currency Risk.
International revenues from the Companys foreign subsidiaries were 0% for the three and six months ended June 30, 2005 and 11% and 14% for the three and six months ended June 30, 2004, respectively, of total revenue and were derived from our
Australian, United Kingdom and Japanese operations.



The
Companys international business was subject to risks typical of an international business, including but not limited to differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions
and foreign exchange rate volatility, particularly the exchange rates between the Australian dollar, the United Kingdom Pound, the Japanese Yen and the United States dollar. In the first quarter of 2004, the Company signed agreements to sell the
assets and activities of its international subsidiaries and has commenced liquidation procedures of all international entities.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------



(a) 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



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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 was
recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and Form 10-Q.



(b) Changes in internal controls. There were no changes in the Companys internal controls over financial reporting during the period
covered by this report



(c) 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 error 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. OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------



In August 2004, Mario Cisneros and Michael Voight filed a private attorney general lawsuit on behalf of a proposed class in Superior Court in San
Francisco County, California. The complaint names thirteen search engines or web publishers as defendants (including the Company) and alleges unfair business practices, unlawful business practices and other causes of action in connection with the
display of advertisements from internet gambling companies. The complaint seeks restitution, unspecified compensatory damages, declaratory and injunctive relief, and attorneys fees. Plaintiffs filed a motion for preliminary injunction and
served discovery requests, and the Company has responded to the complaint and filed a motion to strike certain allegations, which the court denied in part and granted in part. The court also allowed certain discovery to proceed with respect to
plaintiffs motion for preliminary injunction. Recently the court ordered an October 2005 trial on an issue in the case. At this point in time, the Company does not have sufficient information to assess the validity of the complaint or the
amount of potential damages.



In February 2005, Lanes
Gifts and Collectibles, L.L.C. and U.S. Citizens for Fair Credit Card Terms, Inc., filed a lawsuit on behalf of a proposed nationwide class of similarly situated persons in Circuit Court in Miller County, Arkansas. Subsequently, plaintiffs filed
first and second amended complaints adding additional plaintiffs. The Company was served with the second amended complaint in March 2005, which names eleven search engines or web publishers as defendants (including the Company) and alleges breach of
contract, unjust enrichment, civil conspiracy and other causes of action in connection with the sale of clicks not generated by actual consumer click-throughs. The complaint seeks monetary damages, restitution, prejudgment interest, attorneys
fees and other remedies.The case was removed to United States District Court in Arkansas in March 2005. Plaintiffs subsequently filed a motion for remand, which was recently granted. 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. At this point in time, the Company does not have sufficient information to assess the validity of the
complaint or the amount of potential damages.



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We are also 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. 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 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.By:

/s/ WILLIAM B. LONERGANWilliam B. Lonergan, Chief FinancialOfficer(Principal Financial and AccountingOfficer)




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EXHIBIT INDEX



|               |  |                                                                                                                                                                                                                  
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                                                                                                          
|               | 
|3.1(1)         |  | Restated Certificate of Incorporation                                                                                                                                                                            
|               | 
|3.2(2)         |  | Bylaws                                                                                                                                                                                                           
|               | 
|4.1(3)         |  | Form of Specimen Stock Certificate                                                                                                                                                                               
|               | 
|4.2(4)         |  | 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
|               | 
|10.55          |  | Amendment No. 3 to the Prioritized Listings Syndication Agreement between the Registrant and Search123, Inc. dated June 24, 2005.                                                                                
|               | 
|10.56          |  | Amendment No. 2 to the Prioritized Listings Syndication Agreement between the Registrant and Interchange Corporation, dated July 19, 2005.                                                                       
|               | 
|10.57(5)       |  | Employment offer letter between the Registrant and its senior vice president, business development, dated April 19, 2005.                                                                                        
|               | 
|10.57(6)       |  | Amendment to employment offer letter between the Registrant and its chief executive officer, dated June 21, 2005.                                                                                                
|               | 
|10.57(7)       |  | Employment offer letter between the Registrant and its senior vice president and general counsel of the Registrant, dated July 11, 2005.                                                                         
|               | 
|10.58(5)       |  | Employment offer letter between the Registrant and its senior vice president and chief technical officer, dated April 19, 2005.                                                                                  
|               | 
|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                                                                                   

---

|(1) | Filed with the Companys Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999.
|--- | ---------------------------------------------------------------------------------------------------------------------



|(2) | Filed with the Companys Quarterly Report on Form 10-Q filed with the SEC on August 14, 2000.
|--- | ---------------------------------------------------------------------------------------------



|(3) | Filed with the Companys Amendment No. 1 to the Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on July 27, 1999.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Filed with the Companys Current Report on Form 8-K filed with the SEC on October 22, 2004.
|--- | -------------------------------------------------------------------------------------------



|(5) | Filed with the Companys Current Report on Form 8-K filed with the SEC on April 25, 2005.
|--- | -----------------------------------------------------------------------------------------



|(6) | Filed with the Companys Current Report on Form 8-K filed with the SEC on June 21, 2005.
|--- | ----------------------------------------------------------------------------------------



|(7) | Filed with the Companys Current Report on Form 8-K filed with the SEC on July 14, 2005.
|--- | ----------------------------------------------------------------------------------------



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