##### Table of Contents

---

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, 2006

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 a large accelerated filer, an accelerated filer or a non-accelerated filer, as defined in Rule 12b-2 of the Exchange
Act.

Large accelerated filer ̈Accelerated filer   x            
Non-accelerated filer ̈

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

As of August 7, 2006, there were
22,938,835 shares of the registrants common stock outstanding.



---



---

##### Table of Contents

Table of Contents

FORM 10-Q

INDEX



|                             |  |                                                                                                                              |  |     
|---------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------- |  | ----
|                             |  |                                                                                                                              |  | Page
|PART I FINANCIAL INFORMATION |  |                                                                                                                             
|ITEM 1:                      |  | Unaudited Condensed Consolidated Financial Statements                                                                        |  | 3   
|                             |  | Unaudited Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005                                    |  | 3   
|                             |  | Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2006 and June 30, 2005 |  | 4   
|                             |  | Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and June 30, 2005           |  | 5   
|                             |  | Notes to Unaudited Condensed Consolidated Financial Statements                                                               |  | 6   
|ITEM 2:                      |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                        |  | 16  
|ITEM 3:                      |  | Quantitative and Qualitative Disclosures About Market Risk                                                                   |  | 22  
|ITEM 4:                      |  | Controls and Procedures                                                                                                      |  | 23  
|                             | 
|PART II OTHER INFORMATION    |  |                                                                                                                             
|ITEM 1:                      |  | Legal Proceedings                                                                                                            |  | 24  
|ITEM 1A:                     |  | Risk Factors                                                                                                                 |  | 24  
|ITEM 4                       |  | Submission of Matters to a Vote of Security Holders                                                                          |  | 32  
|ITEM 5:                      |  | Other Information                                                                                                            |  | 32  
|ITEM 6:                      |  | Exhibits                                                                                                                     |  | 32  
|ITEM 7:                      |  | Signature                                                                                                                    |  | 33  
|EXHIBIT INDEX                |  | 34                                                                                                                          



2



---

##### Table of Contents

PART I  FINANCIAL INFORMATION



|ITEM 1. | UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|------- | -----------------------------------------------------

LOOKSMART, LTD.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)



|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                                                                                                                       |  | June 30,2006 |          |   | December 31,2005 |  
|ASSETS                                                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  
|Current assets:                                                                                                                                                                                                                        |  |              |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                                                                                                              |  | $            | 29,708   |   |                  | $ | 33,436   |  
|Short-term investments                                                                                                                                                                                                                 |  |              | 12,451   |   |                  |   | 17,871   |  
|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|Total cash, cash equivalents and short-term investments                                                                                                                                                                                |  |              | 42,159   |   |                  |   | 51,307   |  
|Trade accounts receivable, net of allowance for doubtful accounts of $205 and $240 at June 30, 2006 and December 31, 2005,
respectively, and allowance for returns of $17 and $14 at June 30, 2006 and December 31, 2005, respectively |  |              | 3,335    |   |                  |   | 2,781    |  
|Prepaid expenses                                                                                                                                                                                                                       |  |              | 520      |   |                  |   | 443      |  
|Other current assets                                                                                                                                                                                                                   |  |              | 620      |   |                  |   | 569      |  
|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|Total current assets                                                                                                                                                                                                                   |  |              | 46,634   |   |                  |   | 55,100   |  
|Long-term investments                                                                                                                                                                                                                  |  |              | 992      |   |                  |   |         |  
|Property and equipment, net                                                                                                                                                                                                            |  |              | 5,067    |   |                  |   | 5,503    |  
|Capitalized software and other assets, net                                                                                                                                                                                             |  |              | 3,105    |   |                  |   | 2,464    |  
|Intangible assets, net                                                                                                                                                                                                                 |  |              | 4,354    |   |                  |   | 5,519    |  
|Goodwill                                                                                                                                                                                                                               |  |              | 14,422   |   |                  |   | 14,422   |  
|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|Total assets                                                                                                                                                                                                                           |  | $            | 74,574   |   |                  | $ | 83,008   |  
|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|LIABILITIES & STOCKHOLDERS EQUITY                                                                                                                                                                                                     |  |              |          |   |                  |   |          |  
|Current liabilities:                                                                                                                                                                                                                   |  |              |          |   |                  |   |          |  
|Trade accounts payable                                                                                                                                                                                                                 |  | $            | 1,830    |   |                  | $ | 1,629    |  
|Accrued expenses and other current liabilities                                                                                                                                                                                         |  |              | 4,778    |   |                  |   | 4,865    |  
|Deferred revenue and customer deposits                                                                                                                                                                                                 |  |              | 1,938    |   |                  |   | 2,047    |  
|Current portion of lease restructuring and long-term liabilities                                                                                                                                                                       |  |              | 1,471    |   |                  |   | 1,530    |  
|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|Total current liabilities                                                                                                                                                                                                              |  |              | 10,017   |   |                  |   | 10,071   |  
|Lease restructuring and other long-term liabilities, net of current portion                                                                                                                                                            |  |              | 3,814    |   |                  |   | 4,486    |  
|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|Total liabilities                                                                                                                                                                                                                      |  |              | 13,831   |   |                  |   | 14,557   |  
|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|                                                                                                                                                                                                                                       |  |             
|Commitments and contingencies (Note 5)                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  
|Stockholders equity:                                                                                                                                                                                                                  |  |              |          |   |                  |   |          |  
|Convertible preferred stock, $0.001 par value;Authorized: 5,000 at June 30, 2006 and December 31, 2005;Issued and
Outstanding: none at June 30, 2006 and December 31, 2005                                                             |  |              |         |   |                  |   |         |  
|Common stock, $0.001 par value;Authorized: 200,000 at June 30, 2006 and December 31, 2005;Issued and Outstanding: 22,937 at
June 30, 2006 and 22,912 at December 31, 2005, respectively                                                |  |              | 23       |   |                  |   | 23       |  
|Additional paid-in capital                                                                                                                                                                                                             |  |              | 272,991  |   |                  |   | 271,851  |  
|Other equity                                                                                                                                                                                                                           |  |              | 456      |   |                  |   | 386      |  
|Accumulated deficit                                                                                                                                                                                                                    |  |              | (212,727 | ) |                  |   | (203,809 | )
|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|Total stockholders equity                                                                                                                                                                                                             |  |              | 60,743   |   |                  |   | 68,451   |  
|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                                             |  | $            | 74,574   |   |                  | $ | 83,008   |  
|                                                                                                                                                                                                                                       |  |              |          |   |                  |   |          |  

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



3



---

##### Table of Contents

LOOKSMART, LTD.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)



|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------ |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                         |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                                         |  | 2006                       |        |   | 2005                     |   |        | 2006 |  |   | 2005   |  
|Revenues                                                                 |  | $                          | 11,130 |   |                          | $ | 10,225 |      |  | $ | 21,673 |   |  | $ | 22,226  |  
|Cost of revenues                                                         |  |                            | 7,251  |   |                          |   | 6,620  |      |  |   | 14,339 |   |  |   | 14,912  |  
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Gross profit                                                             |  |                            | 3,879  |   |                          |   | 3,605  |      |  |   | 7,334  |   |  |   | 7,314   |  
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Operating expenses:                                                      |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Sales and marketing                                                      |  |                            | 2,096  |   |                          |   | 1,714  |      |  |   | 3,839  |   |  |   | 3,349   |  
|Product development                                                      |  |                            | 4,094  |   |                          |   | 4,332  |      |  |   | 8,377  |   |  |   | 9,097   |  
|General and administrative                                               |  |                            | 2,570  |   |                          |   | 1,539  |      |  |   | 4,997  |   |  |   | 3,721   |  
|Restructuring charges                                                    |  |                            |       |   |                          |   | 1,879  |      |  |   |       |   |  |   | 1,904   |  
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Total operating expenses                                                 |  |                            | 8,760  |   |                          |   | 9,464  |      |  |   | 17,213 |   |  |   | 18,071  |  
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Loss from operations                                                     |  |                            | (4,881 | ) |                          |   | (5,859 | )    |  |   | (9,879 | ) |  |   | (10,757 | )
|Non-operating income, net                                                |  |                            | 482    |   |                          |   | 426    |      |  |   | 961    |   |  |   | 904     |  
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Loss from continuing operations before income taxes                      |  |                            | (4,399 | ) |                          |   | (5,433 | )    |  |   | (8,918 | ) |  |   | (9,853  | )
|Income tax expense                                                       |  |                            |       |   |                          |   | (11    | )    |  |   |       |   |  |   | (13     | )
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Loss from continuing operations                                          |  |                            | (4,399 | ) |                          |   | (5,444 | )    |  |   | (8,918 | ) |  |   | (9,866  | )
|Gain from discontinued operations                                        |  |                            |       |   |                          |   | 28     |      |  |   |       |   |  |   | 110     |  
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Net loss                                                                 |  | $                          | (4,399 | ) |                          | $ | (5,416 | )    |  | $ | (8,918 | ) |  | $ | (9,756  | )
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Basic and diluted net loss per common share:                             |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Loss from continuing operations                                          |  | $                          | (0.19  | ) |                          | $ | (0.24  | )    |  | $ | (0.39  | ) |  | $ | (0.43   | )
|Gain from discontinued operations                                        |  |                            |       |   |                          |   |       |      |  |   |       |   |  |   |        |  
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Net loss                                                                 |  | $                          | (0.19  | ) |                          | $ | (0.24  | )    |  | $ | (0.39  | ) |  | $ | (0.43   | )
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  
|Weighted average shares outstanding used in per common share calculation |  |                            | 22,815 |   |                          |   | 22,757 |      |  |   | 22,810 |   |  |   | 22,752  |  
|                                                                         |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |         |  

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



4



---

##### Table of Contents

LOOKSMART, LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                            |  |                          |        |   |      |   |        |  
|--------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                            |  | Six Months EndedJune 30, |       
|                                                                            |  | 2006                     |        |   | 2005 |  
|Cash flows from operating activities:                                       |  |                          |        |   |      |   |        |  
|Net loss                                                                    |  | $                        | (8,918 | ) |      | $ | (9,756 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                          |        |   |      |   |        |  
|Depreciation and amortization                                               |  |                          | 3,437  |   |      |   | 4,010  |  
|Stock based compensation                                                    |  |                          | 1,020  |   |      |   | (10    | )
|Loss from sale of assets and other non-cash charges                         |  |                          | 82     |   |      |   | 209    |  
|Changes in operating assets and liabilities:                                |  |                          |        |   |      |   |        |  
|Trade accounts receivable, net                                              |  |                          | (554   | ) |      |   | 1,608  |  
|Prepaid expenses                                                            |  |                          | (77    | ) |      |   | 467    |  
|Other assets                                                                |  |                          | (216   | ) |      |   | 290    |  
|Trade accounts payable                                                      |  |                          | 201    |   |      |   | 2,038  |  
|Accrued expenses and other current liabilities                              |  |                          | (790   | ) |      |   | (301   | )
|Deferred revenue and customer deposits                                      |  |                          | (109   | ) |      |   | (3     | )
|                                                                            |  |                          |        |   |      |   |        |  
|Net cash used in operating activities                                       |  |                          | (5,924 | ) |      |   | (1,448 | )
|                                                                            |  |                          |        |   |      |   |        |  
|Cash flows from investing activities:                                       |  |                          |        |   |      |   |        |  
|Purchase of investments                                                     |  |                          | (1,996 | ) |      |   | (5,791 | )
|Maturities of investments                                                   |  |                          | 6,410  |   |      |   | 1,881  |  
|Proceeds from sale of investments                                           |  |                          |       |   |      |   | 5,000  |  
|Payments for property, equipment and capitalized software development       |  |                          | (2,276 | ) |      |   | (1,150 | )
|                                                                            |  |                          |        |   |      |   |        |  
|Net cash provided by (used in) investing activities                         |  |                          | 2,138  |   |      |   | (60    | )
|                                                                            |  |                          |        |   |      |   |        |  
|Cash flows from financing activities:                                       |  |                          |        |   |      |   |        |  
|Repayment of notes                                                          |  |                          | (26    | ) |      |   | (25    | )
|Proceeds from issuance of common stock                                      |  |                          | 84     |   |      |   | 81     |  
|                                                                            |  |                          |        |   |      |   |        |  
|Net cash provided by financing activities                                   |  |                          | 58     |   |      |   | 56     |  
|                                                                            |  |                          |        |   |      |   |        |  
|Decrease in cash and cash equivalents                                       |  |                          | (3,728 | ) |      |   | (1,452 | )
|Cash and cash equivalents, beginning of period                              |  |                          | 33,436 |   |      |   | 45,054 |  
|                                                                            |  |                          |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                    |  | $                        | 29,708 |   |      | $ | 43,602 |  
|                                                                            |  |                          |        |   |      |   |        |  

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



5



---

##### Table of Contents

LOOKSMART, LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business
and Principles of Consolidation

LookSmart is an online media and technology company specializing in vertical search.

The Unaudited Condensed Consolidated Financial Statements as of June 30, 2006 and for the three and six months ended June 30, 2006 include the
accounts of the Company and its subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.

Unaudited
Interim Financial Information

The accompanying Unaudited Condensed Consolidated Financial Statements as of June 30, 2006 and for the three and six
months ended June 30, 2006 reflect all adjustments that 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 Unaudited Condensed
Consolidated Financial Statements should be read in conjunction with the Companys Consolidated Financial Statements and Notes thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
The Unaudited Condensed Consolidated Balance Sheet as of December 31, 2005 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting
principles for complete financial statements. The results of operations for the interim period ended June 30, 2006 are not necessarily indicative of results to be expected for the full year.

Use of Estimates and Assumptions

The Unaudited Condensed
Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States. This requires management to make estimates and assumptions that affect the reported amounts of assets and
liabilities, revenue, expenses, and contingent assets and liabilities during the reporting period. The Company bases its estimates on various factors and information which may include, but are not limited to, history and prior experience, experience
of other enterprises in the same industry, new related events, 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 periods balances have been reclassified to conform to the current years presentation. These
reclassifications did not change the previously reported net loss, net change in cash and cash equivalents or stockholders equity.

Concentration
of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk comprise all or portions of cash
equivalents, short-term investments, long-term investments and accounts receivable. As of June 30, 2006 and December 31, 2005, substantially all of the Companys cash, cash equivalents and investments were managed by one financial
institution. The fair value of these investments is subject to fluctuation based on market prices.

Credit Risk Evaluation

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 estimated credit losses. The Company applies judgment as to its ability to collect outstanding receivables based primarily on managements evaluation of the customers financial condition and past collection
history and records a specific allowance. In addition, the Company records an allowance based on the length of time the accounts receivables are past due. Historically, such losses have been within managements expectations. As of June 30,
2006, one customer accounted for 24% of accounts receivable. As of December 31, 2005, one customer accounted for 28% percent of accounts receivable.



6



---

##### Table of Contents

Revenue Concentrations

The Company derived the following percentages of its revenue primarily from its relationship with significant distribution network partners, as well as customers:



|          |  |                            |   |  |                          |   |  |      |   |  |      |  
|--------- |  | -------------------------- | - |  | ------------------------ | - |  | ---- | - |  | ---- | -
|          |  | Three Months EndedJune 30, |   |  | Six Months EndedJune 30, |  
|          |  | 2006                       |   |  | 2005                     |   |  | 2006 |   |  | 2005 |  
|Company 1 |  | 18                         | % |  | 8                        | % |  | 13   | % |  | 8    | %
|Company 2 |  | 12                         | % |  | 3                        | % |  | 12   | % |  | 3    | %
|Company 3 |  | 8                          | % |  | 24                       | % |  | 6    | % |  | 26   | %

Net Loss per Common Share

Basic net loss per common share is computed by dividing net loss for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing net
loss by the weighted average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options and warrants. Potentially dilutive securities have been excluded from the computation of diluted net loss per
share as their effect is anti-dilutive.

Share-Based Compensation

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which requires the measurement and recognition
of compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan (employee stock purchases) based on
estimated fair values. SFAS 123R supersedes the Companys previous accounting under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25) for periods beginning in fiscal
2006. In March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107 (SAB 107) relating to SFAS 123R. The Company has applied the provisions of SAB 107 in its adoption of SFAS 123R.

The Company adopted SFAS 123R using the modified prospective transition method, which requires the application of the accounting standard as of
January 1, 2006, the first day of the Companys fiscal year 2006. The Companys Unaudited Condensed Consolidated Financial Statements as of June 30, 2006 and for the three and six months ended June 30, 2006 reflect the
impact of SFAS 123R. In accordance with the modified prospective transition method, the Companys Unaudited Condensed Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS
123R. Share-based compensation expense recognized under SFAS 123R for the three and six months ended June 30, 2006 was approximately $0.8 million and $1.1 million respectively, which was related to stock options and employee stock purchases. In
connection with the grant of certain stock options to employees and members of the Board of Directors and in connection with certain acquisitions, the Company recorded a share-based compensation expense (benefit) under APB No. 25 of
approximately $(13,000) and $10,000 during the three and six months ended June 30, 2005, respectively.

SFAS 123R requires companies to estimate the
fair value of share-based payment awards on the grant date using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense in the Companys Unaudited Condensed Consolidated
Statements of Operations over the requisite service periods. Prior to the adoption of SFAS 123R, the Company accounted for share-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under SFAS
123. Under the intrinsic value method, no share-based compensation expense related to stock options had been recognized in the Companys Unaudited Condensed Consolidated Statements of Operations because the exercise price of the Companys
stock options granted to employees and directors equaled the fair market value of the underlying stock at the grant date.

Share-based compensation expense
recognized during the current period is based on the value of the portion of share-based payment awards that is ultimately expected to vest. SFAS 123R requires forfeitures to be estimated at the time of grant in order to estimate the amount of
share-based awards that will ultimately vest. The forfeiture rate is based on historical rates. Share-based compensation expense recognized in the Companys Unaudited Condensed Consolidated Statements of Operations for the second quarter of
fiscal 2006 includes (i) compensation expense for share-based payment awards granted prior to, but not yet fully vested as of December 31, 2005, based on the grant-date fair value estimated in accordance with the pro forma provisions of
SFAS 123 and (ii) compensation expense for the share-based payment awards granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.

Upon adoption of SFAS 123R, the Company continued its use of the Black-Scholes method of valuation for share-based awards granted beginning in fiscal 2006, which was
previously used for the Companys pro forma information required under SFAS 123.

On November 10, 2005, the Financial Accounting Standards Board
(FASB) issued FASB Staff Position No. SFAS 123R-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards(SFASR-3) . The alternative transition method includes simplified methods to
establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and Unaudited Condensed
Consolidated Statements of



7



---

##### Table of Contents

Cash Flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS 123R. The Company is in the process of
evaluating whether to adopt the provisions of SFAS 123R-3.

Segment Information

As of June 30, 2006 and December 31, 2005, all of the Companys accounts receivable, intangible assets, goodwill and deferred revenue related to the online advertising segment. All of the Companys
revenue included in continuing operations was generated in the United States. See Note 7 (Discontinued Operations) regarding foreign revenue reported as discontinued operations. All long-lived assets are located in the United States.

Recently Issued Accounting Pronouncements

In July 2006, FASB issued
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109, (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation
requires that the Company recognizes in its financial statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are
effective as of the beginning of the Companys 2007 fiscal year, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the
impact of adopting FIN 48 on its Consolidated Financial Statements.

2. GOODWILL AND INTANGIBLE ASSETS

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



|                              |  |              |        |   |                  |   |        |  
|----------------------------- |  | ------------ | ------ | - | ---------------- | - | ------ | -
|                              |  | June 30,2006 |        |   | December 31,2005 |  
|Goodwill                      |  | $            | 14,422 |   |                  | $ | 14,422 |  
|                              |  |              |        |   |                  |   |        |  
|Intangible assets:            |  |              |        |   |                  |   |        |  
|Purchased technology          |  | $            | 10,179 |   |                  | $ | 10,179 |  
|Less accumulated amortization |  |              | (7,057 | ) |                  |   | (6,365 | )
|                              |  |              |        |   |                  |   |        |  
|Net purchased technology      |  |              | 3,122  |   |                  |   | 3,814  |  
|                              |  |              |        |   |                  |   |        |  
|Trade names                   |  |              | 1,743  |   |                  |   | 1,743  |  
|Less accumulated amortization |  |              | (717   | ) |                  |   | (516   | )
|                              |  |              |        |   |                  |   |        |  
|Net trade names               |  |              | 1,026  |   |                  |   | 1,227  |  
|                              |  |              |        |   |                  |   |        |  
|Other intangibles             |  |              | 2,170  |   |                  |   | 2,170  |  
|Less accumulated amortization |  |              | (1,964 | ) |                  |   | (1,692 | )
|                              |  |              |        |   |                  |   |        |  
|Net other intangibles         |  |              | 206    |   |                  |   | 478    |  
|                              |  |              |        |   |                  |   |        |  
|Intangible assets, net        |  | $            | 4,354  |   |                  | $ | 5,519  |  
|                              |  |              |        |   |                  |   |        |  

Intangible asset amortization expense was $0.6 million and $1.2 million, for the three and six months ended
June 30, 2006, and $0.6 million and $1.2 million for the three and six months ended 2005, respectively, and was recorded primarily in product development expense.

3. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

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



|                                                |  |              |       |                  |   |      
|----------------------------------------------- |  | ------------ | ----- | ---------------- | - | -----
|                                                |  | June 30,2006 |       | December 31,2005
|Accrued compensation and related expenses       |  | $            | 1,313 |                  | $ | 1,487
|Accrued distribution and partner costs          |  |              | 2,200 |                  |   | 1,936
|Accrued professional services                   |  |              | 518   |                  |   | 723  
|Customer refunds                                |  |              | 25    |                  |   | 82   
|Accrued equipment purchases                     |  |              | 96    |                  |   | 343  
|City business and personal property tax payable |  |              | 281   |                  |   | 78   
|Other                                           |  |              | 345   |                  |   | 216  
|                                                |  |              |       |                  |   |      
|Total accrued liabilities                       |  | $            | 4,778 |                  | $ | 4,865
|                                                |  |              |       |                  |   |      



8



---

##### Table of Contents

4. RESTRUCTURING CHARGES

During 2005, the Company vacated portions of its leased headquarter facilities, and incurred lease restructuring costs related to closing these facilities. These costs are classified as restructuring charges on the Unaudited Condensed
Consolidated Statements of Operations, and are included in operating expenses.

During the first half of 2005, the Company had limited success in
subleasing its unused space since the establishment of the restructuring liability, and modified its original estimates. This resulted in additional restructuring charges of $1.9 million in the second quarter of 2005, reflecting the reduced
probability of subleasing the available space. However in October 2005, the Company and one of its sublessees executed an agreement for an additional portion of the unused space, which resulted in a reduction of the restructuring liability by $0.3
million, recorded in the third quarter of 2005. A further reduction of the restructuring liability by $0.6 million was recorded in the fourth quarter of 2005 based on an agreement with a new sublessee. The lease restructuring liability is amortized
using the interest method through the life of the lease, which terminates in 2009.

As of June 30, 2006 and December 31, 2005, the lease
restructuring liability was $4.7 million and $5.4 million, respectively. Of this amount, $1.2 million and $1.3 million was included in current portion of long-term liabilities as of June 30, 2006 and December 31, 2005, respectively. The
Company does not currently expect to incur significant further restructuring charges or receive additional benefits related to closing redundant leased facilities in 2006 as it has sublet most of its unused space.

The following table sets forth restructuring activity during the period ended June 30, 2006 (in thousands):



|                                          |  |                         |       |  
|----------------------------------------- |  | ----------------------- | ----- | -
|                                          |  | LeaseRestructuringCosts |      
|Balance at December 31, 2005              |  | $                       | 5,398 |  
|Amortization of lease restructuring costs |  |                         | (330  | )
|                                          |  |                         |       |  
|Balance at March 31, 2006                 |  |                         | 5,068 |  
|Amortization of lease restructuring costs |  |                         | (332  | )
|                                          |  |                         |       |  
|Balance at June 30, 2006                  |  | $                       | 4,736 |  
|                                          |  |                         |       |  

5. COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company leases office space under a non-terminable operating lease that expires in 2009.

Future minimum payments under all operating leases and minimum sublease rental income, at June 30, 2006 are as follows (in thousands):



|                                    |  |                 |        |                              |   |      
|----------------------------------- |  | --------------- | ------ | ---------------------------- | - | -----
|Period                              |  | OperatingLeases |        | MinimumSubleaseRental Income
|Six months ending December 31, 2006 |  | $               | 2,311  |                              | $ | 380  
|Fiscal years ending December 31:    |  |                 |        |                              |   |      
|2007                                |  |                 | 4,684  |                              |   | 664  
|2008                                |  |                 | 4,751  |                              |   | 703  
|2009                                |  |                 | 4,412  |                              |   | 618  
|                                    |  |                 |        |                              |   |      
|Total                               |  | $               | 16,158 |                              | $ | 2,365
|                                    |  |                 |        |                              |   |      

The Company has outstanding standby letters of credit (SBLC) related to security of its building lease
and security for payroll processing services of $1.3 million at June 30, 2006. The SBLC contains two financial covenants. As of June 30, 2006, the Company was in compliance with all required covenants.



9



---

##### Table of Contents

Guarantees and Indemnities

During its normal course of business, the Company has made certain guarantees, indemnities and commitments under which it may be required to make payments in relation to certain transactions. These indemnities include intellectual property
and other indemnities to the Companys customers and distribution network partners in connection with the sales of its products, and indemnities to various lessors in connection with facility leases for certain claims arising from such facility
or lease. Further, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was, serving, at the Companys request, in such capacity, to the maximum
extent permitted under the laws of the State of Delaware. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. However, the Company maintains directors and
officers insurance coverage that may contribute, up to certain limits, a portion of any future amounts paid for indemnification of directors and officers. The Company believes the estimated fair value of these indemnification agreements in excess of
applicable insurance coverage is minimal. Historically, the Company has not incurred any losses or recorded any liabilities related to performance under these types of indemnities.

Legal Proceedings

The Company is involved, from time to time, in various legal proceedings arising from the normal
course of business activities. Although the results of litigation and claims cannot be predicted with certainty, the Company does not expect resolution of these matters to have a material adverse impact on its consolidated results of operations,
cash flows or financial position. However, an unfavorable resolution of a matter could, depending on its amount and timing, materially affect its future results of operations, cash flows or financial position in a future period. Regardless of the
outcome, litigation can have an adverse impact on the Company because of defense costs, diversion of management resources and other factors.

Cisneros v. Yahoo! Inc

On August 3, 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 also filed a motion for preliminary injunction on August 3, 2004.

On January 3, 2005, the Company filed a demurrer to the complaint,
which was overruled on January 27, 2005. On January 3, 2005, the Company also filed a motion to strike certain allegations regarding claims for restitution, which was denied in part and granted in part on May 9, 2005. The Company
filed an answer to the complaint on February 28, 2005, consisting of a general denial of all allegations. On October 11, 2005, the court conducted a trial on two of the Companys affirmative defenses. The court held that California
public policy bars the plaintiffs from receiving a portion of their requested damages.

On December 2, 2005, plaintiffs filed a renewed motion for a
preliminary injunction. The Company filed its response on February 27, 2005. The Court has not yet scheduled a hearing for plaintiffs renewed motion. The court has allowed certain discovery to proceed with respect to plaintiffs
renewed motion. On or about April 3, 2006, plaintiffs filed a motion to amend their complaint to add additional plaintiffs. The defendants filed their opposition to the motion on May 1, 2006. On or about May 23, 2006, plaintiffs were
granted leave to amend their complaint to name additional plaintiffs. The Court has set a case management conference for August 28, 2006, and has indicated it will set a briefing and hearing schedule for plaintiffs renewed motion for a
preliminary injunction at that time.

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.

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

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

On March 30, 2005 the case was removed to United States District Court for the Western District of
Arkansas. On April 4, 2005 plaintiffs U.S. Citizens for Fair Credit Card Terms, Inc. and Savings 4 Merchants, Inc. filed a motion of voluntary dismissal without prejudice. The motion was granted on April 7, 2005. Plaintiffs Lanes
Gifts and Collectibles, L.L.C. and Max Caulfield d/b/a Caulfield Investigations filed a motion to remand the case to state court on April 13, 2005, which was granted in June 2005. In July 2005, defendants, including the Company, petitioned the
Eighth Circuit Court of Appeals for an appeal of the remand order, and moved to stay the proceedings while the appeal is pending. The petition was denied on September 8, 2005 and the case was remanded to the Circuit Court of Miller County,
Arkansas. The Company was served with discovery requests on October 7, 2005. The Company has filed and/or joined motions to dismiss on the basis of failure to state a claim upon which relief can be granted, lack of personal jurisdiction, and
improper venue. Pursuant to the courts initial scheduling order, plaintiffs had until January 27, 2006 to respond to the motions to dismiss for lack of personal jurisdiction and improper venue; and until June 9, 2006 to respond to
the motion to dismiss on the basis of failure to state a claim upon which relief can be granted. However the court entered an order staying all proceedings for a period of 60 days on January 9, 2006. On March 8, 2006, the Court entered an
order extending the stay until March 31, 2006. On April 1, 2006, the Court further extended the stay until April 20, 2006. On April 20, 2006 the Court preliminarily approved a class settlement among plaintiffs, defendant Google,
Inc., and certain defendants who display Google



10



---

##### Table of Contents

advertisements on their networks (the Google Settlement). The Google Settlement purports to release Google of all claims and also purports to
release certain defendants, including the Company, for any claims associated with the display of Google advertisements on their networks. On April 21, 2006, the Court ordered the remaining defendants, including the Company, to mediation and
further stayed the proceedings to June 21, 2006. The Court further extended the Stay as to LookSmart until August 16, 2006. On July 24 and 25, 2006, the Court had a final settlement hearing on the Google Settlement, and on
July 26, 2006, the Court approved the settlement.

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.

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. SHARE-BASED COMPENSATION

For the three and six months ended June 30, 2005, the following table illustrates the effect on net loss and net loss per share as if the Company had applied the
fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, to share-based employee compensation (in thousands, except per share data):



|                                                                                                                      |  |                                 |        |   |                               |   |         |  
|--------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ----------------------------- | - | ------- | -
|                                                                                                                      |  | Three Months EndedJune 30, 2005 |        |   | Six Months EndedJune 30, 2005 |  
|Net loss as reported                                                                                                  |  | $                               | (5,416 | ) |                               | $ | (9,756  | )
|Add: Share-based employee compensation (expense) benefit included in reported net loss, net of related tax effects    |  |                                 | (13    | ) |                               |   | 10      |  
|Deduct: Total share-based employee compensation expense determined under fair value method for all awards, net of tax |  |                                 | (496   | ) |                               |   | (1,065  | )
|                                                                                                                      |  |                                 |        |   |                               |   |         |  
|Pro forma net loss                                                                                                    |  | $                               | (5,925 | ) |                               | $ | (10,811 | )
|                                                                                                                      |  |                                 |        |   |                               |   |         |  
|Net loss per share:                                                                                                   |  |                                 |        |   |                               |   |         |  
|As reported                                                                                                           |  | $                               | (0.24  | ) |                               | $ | (0.43   | )
|Pro forma                                                                                                             |  | $                               | (0.26  | ) |                               | $ | (0.48   | )

For the three and six months ended June 30, 2005, the Company used the Black-Scholes option-pricing model to
estimate the pro forma fair value of option grants using the following weighted average assumptions:



|                        |  |                                 |   |  |                               |  
|----------------------- |  | ------------------------------- | - |  | ----------------------------- | -
|                        |  | Three Months EndedJune 30, 2005 |   |  | Six Months EndedJune 30, 2005 |  
|Employee stock options: |  |                                 |   |  |                               |  
|Volatility              |  | 107.5                           | % |  | 110.0                         | %
|Risk-free interest rate |  | 3.7                             | % |  | 3.9                           | %
|Expected term (years)   |  | 4.0                             |   |  | 4.0                           |  
|Expected dividend yield |  |                                |   |  |                              |  

The effect on net loss and net loss per share from the adoption of SFAS 123R on the three and six months ended
June 30, 2006 is as follows:



|                                                       |  |                                 |       |   |                               |   |        |  
|------------------------------------------------------ |  | ------------------------------- | ----- | - | ----------------------------- | - | ------ | -
|                                                       |  | Three Months EndedJune 30, 2006 |       |   | Six Months EndedJune 30, 2006 |  
|Share-based compensation expense by award type:        |  |                                 |       |   |                               |   |        |  
|Employee stock options                                 |  | $                               | 759   |   |                               | $ | 1,044  |  
|Employee stock purchase plan                           |  |                                 | 1     |   |                               |   | 11     |  
|                                                       |  |                                 |       |   |                               |   |        |  
|Total share-based compensation                         |  | $                               | 760   |   |                               | $ | 1,055  |  
|                                                       |  |                                 |       |   |                               |   |        |  
|Effect on net loss                                     |  | $                               | (735  | ) |                               | $ | (1,020 | )
|                                                       |  |                                 |       |   |                               |   |        |  
|Effect on basic and diluted net loss per common share: |  |                                 |       |   |                               |   |        |  
|Basic and diluted                                      |  | $                               | (0.03 | ) |                               | $ | (0.04  | )



11



---

##### Table of Contents

The adoption of SFAS 123R did not have a material impact on income tax expense or cash flows.

Share-based compensation expense recorded during the three and six months ended June 30, 2006 was included in the Companys Unaudited Condensed Consolidated
Statement of Operations as follows (in thousands):



|                               |  |                                 |     |                               |   |      
|------------------------------ |  | ------------------------------- | --- | ----------------------------- | - | -----
|                               |  | Three Months EndedJune 30, 2006 |     | Six Months EndedJune 30, 2006
|Cost of revenues               |  | $                               | 5   |                               | $ | 6    
|Sales and marketing            |  |                                 | 112 |                               |   | 138  
|Product development            |  |                                 | 253 |                               |   | 314  
|General and administrative     |  |                                 | 365 |                               |   | 562  
|                               |  |                                 |     |                               |   |      
|Total share-based compensation |  | $                               | 735 |                               | $ | 1,020
|                               |  |                                 |     |                               |   |      

The Company accounts for employee stock options under SFAS 123R and related interpretations. For the three and six
months ended June 30, 2006, the Company recorded stock based compensation of approximately $0.8 million and $1.1 million, respectively. Of that amount, approximately $25,000 and $35,000, respectively was capitalized related to the development
of internal-use software in accordance with American Institute of Certified Public Accountants (AICPA) Statement of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use
(SOP 98-1).

Valuation Assumptions

As
share-based compensation expense recognized in the Unaudited Condensed Consolidated Statement of Operations for the three and six months ended June 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated
forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the Companys pro forma information required under SFAS 123
for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

For the three and six months ended June 30, 2006, the
fair value of each option grant was estimated on the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions:



|                              |  |                                 |   |  |                               |  
|----------------------------- |  | ------------------------------- | - |  | ----------------------------- | -
|                              |  | Three Months EndedJune 30, 2006 |   |  | Six Months EndedJune 30, 2006 |  
|Employee stock options:       |  |                                 |   |  |                               |  
|Volatility                    |  | 88.5                            | % |  | 91.7                          | %
|Risk-free interest rate       |  | 5.1                             | % |  | 4.8                           | %
|Expected term (years)         |  | 3.7                             |   |  | 3.6                           |  
|Expected dividend yield       |  |                                |   |  |                              |  
|Annual forfeiture rate        |  | 10.0                            | % |  | 11.0                          | %
|Employee stock purchase plan: |  |                                 |   |  |                               |  
|Volatility                    |  | 52.0                            | % |  | 62.0                          | %
|Risk-free interest rate       |  | 5.1                             | % |  | 4.9                           | %
|Expected term (years)         |  | 0.5                             |   |  | 0.5                           |  
|Expected dividend yield       |  |                                |   |  |                              |  
|Annual forfeiture rate        |  |                                |   |  |                              |  



12



---

##### Table of Contents

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

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

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

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

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

The weighted average grant-date fair value of options granted in the three and six months ended June 30, 2006 was $2.77 and $2.96
respectively.

The aggregate intrinsic value of options exercised for the three and six months ended June 30, 2006 was approximately $2,000 and
$17,000, respectively. The Company issues new shares of common stock upon exercise of stock options. No income tax benefits have been realized from exercised stock options.

Total unrecognized share-based compensation expense was approximately $5.5 million as of June 30, 2006, and the weighted average period over which it is expected to be recognized is 2.5 years.

Stock Option Plans

In December 1997, the Company approved the 1998
Stock Option Plan (the Plan). In October 2000, the Company acquired Zeal Media, Inc. and assumed all the stock options outstanding under the 1999 Zeal Media, Inc. Stock Plan (the Zeal Plan). In April 2002, the Company
acquired WiseNut, Inc. and assumed all the stock options outstanding under the WiseNut, Inc. 1999 Stock Incentive Plan (the WiseNut Plan). The Company has reserved 4,647,731, and 4,174,414 shares of common stock for issuance under its
stock option plans at June 30, 2006 and 2005, respectively. Outstanding stock options generally become exercisable over a three or four year period from the grant date and have a term of ten years. Under the Plan, the Company may grant
incentive stock options, nonqualified stock options and stock purchase rights to employees, directors and consultants.

As of June 30, 2006, 2,834,816
options were outstanding and 1,812,555 shares remained available for grant under the Companys plans.

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



|                             |  |                                     |   |  |                                         |      
|---------------------------- |  | ----------------------------------- | - |  | --------------------------------------- | -----
|                             |  | Outstanding OptionsNumber of Shares |   |  | Weighted AverageExercise Price PerShare
|Balance at December 31, 2004 |  | 1,965                               |   |  | $                                       | 10.15
|Granted                      |  | 932                                 |   |  |                                         | 3.81 
|Exercised                    |  | (27                                 | ) |  |                                         | 3.45 
|Expired/forfeited            |  | (1,046                              | ) |  |                                         | 9.42 
|                             |  |                                     |   |  |                                         |      
|Balance at December 31, 2005 |  | 1,824                               |   |  |                                         | 7.31 
|Granted                      |  | 1,267                               |   |  |                                         | 4.62 
|Exercised                    |  | (9                                  | ) |  |                                         | 3.23 
|Expired/forfeited            |  | (175                                | ) |  |                                         | 7.54 
|                             |  |                                     |   |  |                                         |      
|Balance at March 31, 2006    |  | 2,907                               |   |  |                                         | 6.13 
|Granted                      |  | 178                                 |   |  |                                         | 4.36 
|Exercised                    |  | (2                                  | ) |  |                                         | 3.26 
|Expire/forfeited             |  | (248                                | ) |  |                                         | 5.33 
|                             |  |                                     |   |  |                                         |      
|Balance at June 30, 2006     |  | 2,835                               |   |  | $                                       | 6.10 
|                             |  |                                     |   |  |                                         |      



13



---

##### Table of Contents

The following table summarizes information about stock options outstanding at June 30, 2006:



|                        |       |                                |   |                                     |  |                              |  |                         |  |                                |       |                              |   |                         |  |         |  |   |       |  |   |       
|----------------------- | ----- | ------------------------------ | - | ----------------------------------- |  | ---------------------------- |  | ----------------------- |  | ------------------------------ | ----- | ---------------------------- | - | ----------------------- |  | ------- |  | - | ----- |  | - | ------
|                        |       |                                |   | Outstanding                         |  | Exercisable                 
|Range of ExercisePrices |       | NumberOutstandingAs of06/30/06 |   | WeightedAverageRemainingContractual |  | WeightedAverageExercisePrice |  | AggregateIntrinsicValue |  | NumberExercisableAs of06/30/06 |       | WeightedAverageExercisePrice |   | AggregateIntrinsicValue
|$                       | 1.25  |                                | $ | 4.60                                |  | 734,035                      |  | 9.14                    |  | $                              | 3.58  |                              | $ | 54,053                  |  | 236,241 |  | $ | 3.41  |  | $ | 21,917
|$                       | 4.60  |                                | $ | 4.61                                |  | 1,081,563                    |  | 9.68                    |  | $                              | 4.61  |                              |   |                         |  | 57,187  |  | $ | 4.61  |  |   |       
|$                       | 4.61  |                                | $ | 10.40                               |  | 728,387                      |  | 8.20                    |  | $                              | 7.84  |                              |   |                         |  | 372,619 |  | $ | 7.76  |  |   |       
|$                       | 10.40 |                                | $ | 85.31                               |  | 290,831                      |  | 7.36                    |  | $                              | 13.58 |                              |   |                         |  | 214,236 |  | $ | 13.98 |  |   |       
|                        |       |                                |   |                                     |  |                              |  |                         |  |                                |       |                              |   |                         |  |         |  |   |       |  |   |       
|$                       | 1.25  |                                | $ | 85.31                               |  | 2,834,816                    |  | 8.92                    |  | $                              | 6.10  |                              |   |                         |  | 880,283 |  | $ | 7.90  |  |   |       
|                        |       |                                |   |                                     |  |                              |  |                         |  |                                |       |                              |   |                         |  |         |  |   |       |  |   |       

Aggregate intrinsic value represents the total pretax intrinsic value, based on the Companys closing stock
price on June 30, 2006 ($3.24), which would have been received by option holders had all option holders exercised their options on that date.

As of
June 30, 2005, there were 1,807,451 options outstanding and 849,430 options exercisable.

Employee Stock Purchase Plan

In July 1999, the stockholders approved the 1999 Employee Stock Purchase Plan (the ESPP Plan). At June 30, 2006, a total of 480,000 shares of common
stock were reserved for issuance under the ESPP Plan, plus annual increases at the Boards discretion effective on January 1 of each year, beginning in 2000. As of June 30, 2006, 410,491 shares have been issued under the ESPP Plan and
69,509 shares remain available for issuance.

7. DISCONTINUED OPERATIONS

In January 2004, the Company agreed to sell certain assets and related intellectual property rights of its Australian, Japanese and United Kingdom subsidiaries.

As the Company finalizes the liquidation process of its Australian subsidiary, it expects to record additional income related to the reversal of the cumulative
translation adjustment of approximately $0.5 million in 2006.

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



|                                             |  |                            |   |                           |   |      |  |      |   |  |   |    
|-------------------------------------------- |  | -------------------------- | - | ------------------------- | - | ---- |  | ---- | - |  | - | ---
|                                             |  | Three Months EndedJune 30, |   | Six Months Ended June 30,
|                                             |  | 2006                       |   | 2005                      |   | 2006 |  | 2005
|Revenue                                      |  | $                          |  |                           | $ |     |  | $    |  |  | $ |   
|                                             |  |                            |   |                           |   |      |  |      |   |  |   |    
|Pretax net loss (excluding gain on disposal) |  |                            |  |                           |   |     |  |      |  |  |   |   
|Tax benefit                                  |  |                            |  |                           |   |     |  |      |  |  |   | 67 
|Gain on disposal                             |  |                            |  |                           |   | 28   |  |      |  |  |   | 43 
|                                             |  |                            |   |                           |   |      |  |      |   |  |   |    
|Net gain from discontinued operations        |  | $                          |  |                           | $ | 28   |  | $    |  |  | $ | 110
|                                             |  |                            |   |                           |   |      |  |      |   |  |   |    



14



---

##### Table of Contents

8. COMPREHENSIVE INCOME (LOSS)

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



|                                             |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|-------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                             |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                             |  | 2006                       |        |   | 2005                     |   |        | 2006 |  |   | 2005   |  
|Net loss                                     |  | $                          | (4,399 | ) |                          | $ | (5,416 | )    |  | $ | (8,918 | ) |  | $ | (9,756 | )
|Other comprehensive gain (loss):             |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Change in realized gain (loss) in investment |  |                            | 38     |   |                          |   | 37     |      |  |   | 69     |   |  |   | (40    | )
|                                             |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Comprehensive loss                           |  | $                          | (4,361 | ) |                          | $ | (5,379 | )    |  | $ | (8,849 | ) |  | $ | (9,796 | )
|                                             |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  

9. RELATED PARTY TRANSACTIONS

The Company has a related party receivable from the BT LookSmart joint venture. The investment balance at June 30, 2006 is approximately $0.3 million, which reflects the estimated value upon final liquidation of
the joint venture.



15



---

##### 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 Unaudited Condensed Consolidated Financial Statements and the Notes to those statements which appear elsewhere in this Quarterly Report on Form 10-Q.

The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as believes, intends, expects, anticipates, plans, may, will and similar
expressions to identify forward-looking statements. Discussions containing forward-looking statements may be found in the material set forth under Managements Discussion and Analysis of Financial Condition and Results of Operations
and in other sections of this report. All forward-looking statements, including, but not limited to, projections, expectations or estimates concerning our business, including demand for our products and services, mix of revenue streams, ability to
control and/or reduce operating expenses, anticipated gross margins and operating results, anticipated levels of restructuring charges, cost savings, product development efforts, general outlook of our business and industry, future profits or
losses, opportunities abroad, competitive position, share-based compensation, and adequate liquidity to fund our operations and meet our other cash requirements, are inherently uncertain as they are based on our expectations and assumptions
concerning future events. These forward-looking statements are subject to numerous known and unknown risks and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from
those anticipated in the forward-looking statements for many reasons, including our ability to achieve or maintain net profitability in future quarters, our ability to expand and diversify our network of distribution partners, our continued ability
to license AdCenter for Publishers product, the success of our online advertising business, and all other risks described below in the section entitled Risk Factors and elsewhere in this report. All forward-looking statements in this
report are made as of the date hereof, based on information available to us as of the date hereof, and except as required by applicable law, we assume no obligation to update any forward-looking statements.

All share and per share information provided in this Quarterly Report is presented giving effect to the one-for-five reverse stock split of our common stock effected on
October 26, 2005.

BUSINESS OVERVIEW

LookSmart is an online media and technology company specializing in vertical search. We provide relevant content, advertising and technology solutions for consumers, advertisers and publishers. Our owned-and-operated vertical search sites
are where consumers look for what they need. Our sites and web tools offer search results with the ability to find, save and share resources from and links to websites and online publishers. In addition to owned-and-operated properties, our
distribution network includes selected, monitored, syndicated publishers and search engine partners who improve advertiser return on investment. We also offer a comprehensive and customizable set of syndicated solutions for publishers to grow their
advertiser relationships and audience.

We operate 181 vertical search sites in 13 categories, delivering consumers relevant search results and advertisers
a more qualified customer. For each vertical category, we develop an array of niche sites. For example, our Health web sites include topics such as: alternative medicines, pregnancy, sports medicine diseases, fitness and more. Content found through
our vertical search sites is freely accessible and from a wide variety of sources, including online publishers, print-based magazines, directories, specialized listings, and unique references related to the subject areas.

In addition, there are specific ways to save and share what consumers have searched for, using Furl.net (our proprietary technology) functionality embedded in the site
navigational elements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our financial condition and results of operations are based upon certain critical accounting policies, which include estimates, assumptions, and judgments on the part of management. We base our estimates on various
factors and information which may include, but are not limited to, history and prior experience, experience of other enterprises in the same industry, new related events, current economic conditions and information from third party professionals
that is believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These estimates, judgments and
assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the period presented. Actual results may differ from those estimates.
The following discussion highlights those policies and the underlying estimates and assumptions, which we consider critical to an understanding of the financial information in this report.

Revenue Recognition

Online Advertising

Prior to 2005, online advertising revenue was captioned as listings revenue in our Unaudited Condensed Consolidated Statements of Operations. Our online advertising
revenue is primarily composed of per-click fees that we charge customers. Customers set the per-click fee



16



---

##### Table of Contents

charged for inclusion-targeted listings when their account is established. The per-click fee charged for keyword-targeted listings is calculated based on the
results of online bidding for keywords or page content, up to a maximum cost per keyword or page content set by the customer.

Revenue associated with
online advertising products, including LookListings, FindArticles, our vertical search sites, and banner advertisements are generally recognized once collectibility is established, delivery of services has occurred, all performance obligations have
been satisfied, and no refund obligations exist. We pay distribution network partners based on clicks on the advertisers ad that are displayed on the websites of these distribution network partners. These payments are called traffic
acquisition costs and are included in cost of revenue. In accordance with Emerging Issues Task Force Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent ( EITF 99-19), the revenue derived from these
arrangements that involve traffic supplied by distribution network partners is reported gross of the payment to the distribution network partners. This revenue is reported gross due to the fact that we are the primary obligor to the advertisers who
are the customers of the advertising service.

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

We also enter into agreements to provide private-labeled versions of our products, including the Ad Center and Furl product. These arrangements include multiple elements such as upfront fees, license fees, and revenue-sharing based on the
publishers customers monthly revenue generated through the Ad Center application. We recognize revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, Revenue Recognition in Financial
Statements (SAB 104), and Financial Accounting Standards Board Emerging Issues Task Force No. 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21). We recognize upfront fees over the term of the
arrangement or the expected period of performance, license fees over the term of the license, and revenue-sharing portions over the period in which such revenue is earned. In all cases, revenue is recognized only when the price is fixed or
determinable, persuasive evidence of an arrangement exists, the service is performed, and collectibility of the resulting receivable is reasonably assured.

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

We also recognize revenue from the sale of our Net Nanny software product. Software revenue is recognized upon shipment, provided pervasive evidence of
arrangement exists, price is fixed and determinable, collection is determined to be probable and no significant obligations remain on our part. Revenue from distributors is subject to agreements allowing certain rights of return. Accordingly,
recognized revenue is reduced by estimated future returns at the time the related revenue is recorded. The estimates for returns are adjusted periodically based upon historical rates of returns, inventory levels in the distribution channel and other
related factors. We record royalties when distribution network partners ship products incorporating our software, provided collection of such revenue is deemed probable. We provide a provision against revenue for estimated reductions resulting
from billing adjustments and product returns. The amounts of these provisions are evaluated periodically based upon customer experience and historical trends. Revenue for products sold on a subscription basis is recognized ratably over the
subscription period.

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

Allowance for Doubtful Accounts

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

Valuation of Goodwill and Intangible Assets

We have recorded goodwill and intangible assets in connection with our
business acquisitions. Management exercises judgment in the assessment of the related useful lives, fair value and recoverability of these assets. The majority of intangible assets are amortized over three to seven years, the period of expected
benefit. Goodwill is not amortized. In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142), we periodically re-assess the valuation and asset lives of
intangible assets to conform to changes in managements estimates of future performance. Management considers existing and anticipated competitive and economic conditions in such assessments. Goodwill is reviewed for impairment at least
annually and as a result of any event that significantly changes our business.



17



---

##### Table of Contents

Deferred Taxes

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

Internal Use Software Development Costs

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

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

Restructuring Charges

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

Shared-Based Compensation

On January 1, 2006, we adopted SFAS 123R, which requires the measurement and recognition of compensation
expense for all share-based compensation awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan (employee stock purchases) based on estimated fair
values. SFAS 123R supersedes our previous accounting under APB No. 25 for periods beginning in fiscal 2006. In March 2005, the SEC issued SAB 107 relating to SFAS 123R. We have applied the provisions of SAB 107 in our adoption of SFAS
123R.

Recent Accounting Pronouncements

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

RESULTS OF OPERATIONS

Overview of the Three and Six Months Ended June 30, 2006

During the three and six months ended June 30, 2006 we continued to focus on the following primary operating priorities:



| |  |  | Growing our ad network. Total paid clicks for the second quarter of 2006 were 87 million compared to 80 million in the second quarter of 2005. On a
year-to-date basis, total paid clicks were 161 million in 2006 compare to 163 million in 2005. In the second quarter of 2006, our average revenue per click (RPC) was $0.10 per click, compared to $0.12 per click for the second
quarter of 2005. On a year-to-date basis, our average RPC for 2006 was $0.11 compared to $0.13 in 2005. Our average RPC declined as we added a low priced Run-of-Site advertising product in the third quarter of 2005 which helps us generate revenue
from our ad network more quickly. We continue to eliminate low-converting traffic to improve traffic quality and optimize traffic flow from our distribution network partners.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Developing syndicated solutions for publishers. We continued focusing on our private-labeled Ad Center, providing web search and search of a publishers own
archived content, and providing a tailored version of our Furl online book marking system for publishers. During the quarter, we generated revenue under agreements with two companies. We obtained four new customers during the second quarter.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 operate 181 vertical search sites in 13 different categories.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Substantially all of our revenue is derived via online advertising either on a pay per click or pay per impression basis.



18



---

##### Table of Contents

Revenue



|               |  |                            |        |        |   |        |                          |   |        |  |   |        |  |   |        |  |    |   
|-------------- |  | -------------------------- | ------ | ------ | - | ------ | ------------------------ | - | ------ |  | - | ------ |  | - | ------ |  | -- | --
|               |  | Three Months EndedJune 30, |        | Change |   |        | Six Months EndedJune 30, |   | Change | 
|(in thousands) |  | 2006                       |        | 2005   |   |        | 2006                     |   | 2005   | 
|Revenue        |  | $                          | 11,130 |        | $ | 10,225 |                          | 9 | %      |  | $ | 21,673 |  | $ | 22,226 |  | (2 | )%

Revenue in the second quarter of 2006 increased compared to the second quarter of 2005 primarily due to increased
volume of paid clicks. Average RPC declined $0.02 over the same period. Increased revenue from publisher services solutions also contributed to revenue growth. On a year-to-date basis, revenue decreased slightly from 2005 as a result of lower paid
click volume. Total paid clicks decreased 2% and average RPC declined from $0.13 to $0.11 during the six month period. The decline in average RPC is due to the addition of the Run-of-Site advertising product in the third quarter of 2005. The decline
in revenue resulting from lower click volume and average RPC was offset by increased revenue from our publisher services solutions.

Revenue for the third
quarter of 2006 is expected to increase 6-8% over the second quarter as we continue to focus on growing online advertising revenue from our ad network, consumer owned-and-operated sites and publisher services assets.

Cost of Revenue



|                          |  |                            |       |   |        |   |       |                          |      |    |        |      |   |        |   |  |   |        |   |  |     |   
|------------------------- |  | -------------------------- | ----- | - | ------ | - | ----- | ------------------------ | ---- | -- | ------ | ---- | - | ------ | - |  | - | ------ | - |  | --- | --
|                          |  | Three Months EndedJune 30, |       |   | Change |   |       | Six Months EndedJune 30, |      |    | Change |     
|(in thousands)            |  | 2006                       |       |   | 2005   |   |       |                          | 2006 |    |        | 2005 |   |       
|Traffic acquisition costs |  | $                          | 5,862 |   |        | $ | 5,224 |                          |      | 12 | %      |      | $ | 11,413 |   |  | $ | 11,888 |   |  | (4  | )%
|Percentage of revenues    |  |                            | 53    | % |        |   | 51    | %                        |      |    |        |      |   | 53     | % |  |   | 53     | % |  |     |   
|Content costs             |  |                            | 251   |   |        |   | 149   |                          |      | 68 | %      |      |   | 616    |   |  |   | 330    |   |  | 87  | % 
|Other costs               |  |                            | 1,138 |   |        |   | 1,247 |                          |      | (9 | )%     |      |   | 2,310  |   |  |   | 2,694  |   |  | (14 | )%
|                          |  |                            |       |   |        |   |       |                          |      |    |        |      |   |        |   |  |   |        |   |  |     |   
|Total cost of revenues    |  | $                          | 7,251 |   |        | $ | 6,620 |                          |      | 10 | %      |      | $ | 14,339 |   |  | $ | 14,912 |   |  | (4  | )%
|Percentage of revenues    |  |                            | 65    | % |        |   | 65    | %                        |      |    |        |      |   | 66     | % |  |   | 67     | % |  |     |   

During 2006, in accordance with SFAS 123R, we accounted for employee stock options as share-based compensation
expense which was included in our Condensed Consolidated Statements of Operations. For the three and six months ended June 30, 2006, approximately $5,000 and $6,000, respectively, was included in cost of revenues.

Gross margin of 35% in the second quarter of 2006 was consistent to the second quarter of 2005. On a year-to-date basis, gross margin improved slightly to 34% compared
to 33% for the same period in 2005. Traffic acquisition costs, the costs paid to our distribution network partners, increased in the second quarter of 2006 compared to the second quarter of 2005, due to an increase in online advertising revenue as
well as ongoing quality improvement efforts. For the six months ended June 30, 2006, traffic acquisition costs decreased slightly, due to overall operating improvements in the Ad Network.

Content costs represent amounts paid to license searchable content and search results that are displayed on our network of owned-and-operated sites. Content costs
increased in the second quarter and first half of 2006 compared to the second quarter and first half of 2005 due to increased costs from the launch of our vertical search sites in the third quarter of 2005.

Other costs of revenue consist of connectivity costs, personnel costs of certain operations employees, including share-based compensation, equipment depreciation,
expenses relating to hosting advertising operations, commissions paid to advertising agencies and amortization of intangible assets. These costs decreased in the second quarter of 2006 compared to the second quarter of 2005 primarily due to a
reduction in connectivity costs resulting from cost efficiency efforts. Similarly, these costs decreased on a year-to-date basis.

We expect gross margin
to increase approximately 1% in the third quarter of 2006.

Operating Expenses

Sales and Marketing



|                       |  |                            |       |   |        |   |       |                          |      |    |        |      |   |       |   |  |   |       |   |  |    |  
|---------------------- |  | -------------------------- | ----- | - | ------ | - | ----- | ------------------------ | ---- | -- | ------ | ---- | - | ----- | - |  | - | ----- | - |  | -- | -
|                       |  | Three Months EndedJune 30, |       |   | Change |   |       | Six Months EndedJune 30, |      |    | Change |     
|(in thousands)         |  | 2006                       |       |   | 2005   |   |       |                          | 2006 |    |        | 2005 |   |      
|Sales and marketing    |  | $                          | 2,096 |   |        | $ | 1,714 |                          |      | 22 | %      |      | $ | 3,839 |   |  | $ | 3,349 |   |  | 15 | %
|Percentage of revenues |  |                            | 19    | % |        |   | 17    | %                        |      |    |        |      |   | 18    | % |  |   | 15    | % |  |    |  

During 2006, in accordance with SFAS 123R, we accounted for employee stock options as share-based compensation
expense which was included in our Condensed Consolidated Statements of Operations. For the three and six months ended June 30, 2006, approximately $112,000 and $138,000, respectively, was included in sales and marketing costs.

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



19



---

##### Table of Contents

and reductions of the allowance for doubtful trade receivables. Sales and marketing expenses also include the costs of advertising, trade show, public
relations and various other activities supporting our customer acquisition efforts.

Sales and marketing expenses in the second quarter of 2006 increased
compared to the second quarter of 2005 primarily due to higher trade show and online promotional and marketing expenses. This increase was somewhat offset by lower labor costs in the first quarter of 2006. For the six months ended June 30,
2006, sales and marketing expenses increased compared to the same period in 2005 as a result of increased online promotional and marketing expenses.

Sales
and marketing expenses are expected to increase during 2006 as we support ongoing revenue growth.

Product Development



|                                       |  |                            |       |   |        |   |       |                          |      |     |        |      |   |         |   |  |   |       |   |  |     |   
|-------------------------------------- |  | -------------------------- | ----- | - | ------ | - | ----- | ------------------------ | ---- | --- | ------ | ---- | - | ------- | - |  | - | ----- | - |  | --- | --
|                                       |  | Three Months EndedJune 30, |       |   | Change |   |       | Six Months EndedJune 30, |      |     | Change |     
|(in thousands)                         |  | 2006                       |       |   | 2005   |   |       |                          | 2006 |     |        | 2005 |   |        
|Capitalized software development costs |  |                            | ($513 | ) |        |   | ($181 | )                        |      | 183 | %      |      |   | ($1,169 | ) |  |   | ($307 | ) |  | 281 | % 
|Other product development costs        |  |                            | 4,607 |   |        |   | 4,513 |                          |      | 2   | %      |      |   | 9,546   |   |  |   | 9,404 |   |  | 2   | % 
|                                       |  |                            |       |   |        |   |       |                          |      |     |        |      |   |         |   |  |   |       |   |  |     |   
|Total product development expenses     |  | $                          | 4,094 |   |        | $ | 4,332 |                          |      | (5  | )%     |      | $ | 8,377   |   |  | $ | 9,097 |   |  | (8  | )%
|Percentage of revenues                 |  |                            | 37    | % |        |   | 42    | %                        |      |     |        |      |   | 39      | % |  |   | 41    | % |  |     |   

During 2006, in accordance with SFAS 123R, we accounted for employee stock options as share-based compensation
expense which was included in our Condensed Consolidated Statements of Operations. For the three and six months ended June 30, 2006, approximately $253,000 and $314,000, respectively, was included in product development costs.

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 share-based compensation, overhead, facilities and amortization of intangible assets. Costs related to the development
of software for internal use in the business, including salaries and associated costs of employment are capitalized after certain milestones have been achieved. Software licensing and computer equipment depreciation related to supporting product
development functions are also included in product development expenses.

Capitalized software development costs include the costs to develop software for
internal use, excluding costs associated with research and development, training and testing. The increase in the amount capitalized for the second quarter of 2006 compared to the second quarter of 2005 was primarily related to an increase in the
magnitude and number of ongoing capitalizable projects in 2006. For the same reasons, year-to-date expenses for 2006 are also higher than the same period in 2005. During the first quarter of 2006 we were developing our next generation Ad Center, a
system that allows advertisers to upload listings ads and bid for placement of those ads, collects click data for each listing that we manage for our customers, filters out invalid clicks, and provides customer billing. The new Ad Center was
successfully launched in May 2006. In addition, we developed projects to further enhance other core assets, such as Furl and vertical search technologies, associated with our network of owned-and-operated sites.

The slight increase in other product development expenses in the second quarter of 2006 compared to the second quarter of 2005 relates to the increased level of
development described above.

Both capitalized software development and other product development costs are expected to increase in 2006 as we increase our
product development resources to support further enhancement of our technology platforms.

General and Administrative



|                           |  |                            |       |   |        |   |       |                          |      |    |        |      |   |       |   |  |   |       |   |  |    |  
|-------------------------- |  | -------------------------- | ----- | - | ------ | - | ----- | ------------------------ | ---- | -- | ------ | ---- | - | ----- | - |  | - | ----- | - |  | -- | -
|                           |  | Three Months EndedJune 30, |       |   | Change |   |       | Six Months EndedJune 30, |      |    | Change |     
|(in thousands)             |  | 2006                       |       |   | 2005   |   |       |                          | 2006 |    |        | 2005 |   |      
|General and administrative |  | $                          | 2,570 |   |        | $ | 1,539 |                          |      | 67 | %      |      | $ | 4,997 |   |  | $ | 3,721 |   |  | 34 | %
|Percentage of revenues     |  |                            | 23    | % |        |   | 15    | %                        |      |    |        |      |   | 23    | % |  |   | 17    | % |  |    |  

During 2006, in accordance with SFAS 123R, we accounted for employee stock options as share-based compensation
expense which was included in our Condensed Consolidated Statements of Operations. For the three and six months ended June 30, 2006, approximately $365,000 and $562,000, respectively, was included in general and administrative costs.

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

The increase in general and administrative expenses in the second quarter and first half of 2006 compared to the second quarter and first half of
2005 was primarily due to share-based compensation costs of employees and directors, as we began included share-based compensations costs in net income as of January 1, 2006 as required by SFAS 123R. Compared with the first half of 2006,
general and administrative expenses are expected to decrease over the remainder of the year as a majority of our annual professional services fees including the fees in connection with the our annual financial audit and related Sarbanes-Oxley
compliance certification are incurred in the first two quarters.



20



---

##### Table of Contents

Restructuring Costs



|                       |  |                            |   |   |        |   |       |                          |      |      |        |      |   |   |   |  |   |       |   |  |      |   
|---------------------- |  | -------------------------- | - | - | ------ | - | ----- | ------------------------ | ---- | ---- | ------ | ---- | - | - | - |  | - | ----- | - |  | ---- | --
|                       |  | Three Months EndedJune 30, |   |   | Change |   |       | Six MonthsEnded June 30, |      |      | Change |     
|(in thousands)         |  | 2006                       |   |   | 2005   |   |       |                          | 2006 |      |        | 2005 |   |  
|Restructuring charges  |  | $                          |  |   |        | $ | 1,879 |                          |      | (100 | )%     |      | $ |  |   |  | $ | 1,904 |   |  | (100 | )%
|Percentage of revenues |  |                            |  | % |        |   | 18    | %                        |      |      |        |      |   |  | % |  |   | 9     | % |  |      |   

During 2005, we vacated portions of our leased headquarter facilities, and incurred lease restructuring costs
related to closing these facilities. These costs are classified as restructuring charges on the Unaudited Condensed Consolidated Statements of Operations, and are included in operating expenses. The lease restructuring liability is amortized using
the interest method through the life of the lease, which terminates in 2009.

During the first half of 2005, we had limited success in subleasing our
unused space since the establishment of the restructuring liability, and modified our original estimates. This resulted in additional restructuring charges of approximately $1.9 million in the second quarter of 2005, reflecting the reduced
probability of subleasing the available space. However in October 2005, we executed an agreement to sublease an additional portion of the unused space, which resulted in a reduction of the restructuring liability by approximately $0.3 million,
recorded in the third quarter of 2005. A further reduction of the restructuring liability of $0.6 million was recorded in the fourth quarter of 2005 based on an agreement with a new sublessee. We do not currently expect to record significant further
restructuring charges or benefits related to closing redundant leased facilities in 2006 as we have sublet most of our unused space.

Non-Operating
Income, net



|                          |  |                             |     |        |   |     |                          |    |        |  |     |  |   |     |  |   |  
|------------------------- |  | --------------------------- | --- | ------ | - | --- | ------------------------ | -- | ------ |  | --- |  | - | --- |  | - | -
|                          |  | Three Months Ended June 30, |     | Change |   |     | Six Months EndedJune 30, |    | Change | 
|(in thousands)            |  | 2006                        |     | 2005   |   |     | 2006                     |    | 2005   | 
|Non-operating income, net |  | $                           | 482 |        | $ | 426 |                          | 13 | %      |  | 961 |  | $ | 904 |  | 6 | %

Interest and other non-operating income increased in the second quarter of 2006 compared to the second quarter of
2005 primarily due to higher overall returns earned by our investment portfolio, which had lower average balances in 2006 compared to 2005. Non-operating income increased for the first six months of 2006 compared to the first six months of 2005.
This increase is a result of higher overall returns from our investment portfolio.

Income Tax Expense



|                   |  |                            |   |        |   |    |                          |      |        |  |   |   |  |   |    |  |      |   
|------------------ |  | -------------------------- | - | ------ | - | -- | ------------------------ | ---- | ------ |  | - | - |  | - | -- |  | ---- | --
|                   |  | Three Months EndedJune 30, |   | Change |   |    | Six Months EndedJune 30, |      | Change | 
|(in thousands)     |  | 2006                       |   | 2005   |   |    | 2006                     |      | 2005   | 
|Income tax expense |  | $                          |  |        | $ | 11 |                          | (100 | )%     |  | $ |  |  | $ | 13 |  | (100 | )%

The effective tax rate in upcoming quarters and for the year ending December 31, 2006 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.

Gain from Discontinued Operations, Net of Tax



|                                              |  |                            |   |        |   |    |                          |      |        |  |   |   |  |   |     |  |      |   
|--------------------------------------------- |  | -------------------------- | - | ------ | - | -- | ------------------------ | ---- | ------ |  | - | - |  | - | --- |  | ---- | --
|                                              |  | Three Months EndedJune 30, |   | Change |   |    | Six Months EndedJune 30, |      | Change | 
|(in thousands)                                |  | 2006                       |   | 2005   |   |    | 2006                     |      | 2005   | 
|Gain from discontinued operations, net of tax |  | $                          |  |        | $ | 28 |                          | (100 | )%     |  | $ |  |  | $ | 110 |  | (100 | )%

In January 2004, we agreed to sell certain assets and related intellectual property rights of our Australian,
Japanese and United Kingdom subsidiaries. The gain on disposal of these operations of $1.0 million, net of $0.4 million for transitional expenses, was recorded in 2004. In 2005, we recognized an additional gain of $0.1 million related to additional
disposal activities and an increased tax benefit.



21



---

##### Table of Contents

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 approximately $0.5 million in 2006.

Liquidity and Capital Resources

The following table presents our cash flows provided by (used in) operating, investing and financing activities for the six months ended June 30, 2006 and 2005 (in
thousands):



|                                                      |  |                          |        |   |      |   |        |  
|----------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                      |  | Six Months EndedJune 30, |       
|                                                      |  | 2006                     |        |   | 2005 |  
|Cash flows used in operating activities               |  | $                        | (5,924 | ) |      | $ | (1,448 | )
|Cash flows provided by (used in) investing activities |  | $                        | 2,138  |   |      | $ | (60    | )
|Cash flows provided by financing activities           |  | $                        | 58     |   |      | $ | 56     |  

Our primary source of cash is receipts from revenue. The primary uses of cash are payroll (salaries, benefits, and
other employee compensation), general operating expenses (office rent, utilities, insurance and supplies), payments to distribution network partners related to traffic acquisition and content costs associated with owned and operated sites, and
professional services fees related to legal and audit costs. We ended the second quarter of 2006 with $43.2 million in cash, cash equivalents, and short and long-term investments, a decrease of $8.1 million from December 31, 2005 of $51.3
million.

The increase in cash used in operating activities in the first half of 2006 compared to the first half of 2005 was primarily due to a decrease of
$2.2 million in cash collected from accounts receivable, as well as a decrease of $1.8 million in cash paid for accounts payable.

Net cash provided by
investing activities in the first half of 2006 was higher than net cash used in investing activities in the first half of 2005. We purchased $4.8 million less investments in 2006. Of the $2.0 million in investments we purchased in 2006,
$1.0 million was classified as long term. Further, $1.9 million more investments matured in 2005 compared to 2006, which decreased cash used in 2006. Additionally, we invested $1.2 million more in property, equipment and capitalized software
development in the first half of 2006 compared to the same period in 2005.

Net cash provided by financing activities in the first half of 2006 was
consistent with the first half of 2005 representing payments against the principal balance of our outstanding note payable and proceeds for the issuance of common stock related to our employee stock plans.

We have outstanding standby letters of credit (SBLC) of $1.3 million at June 30, 2006 related to security of a building lease and security for payroll
processing services. The SBLC contains two financial covenants. As of June 30, 2006, we were in compliance with all required covenants.

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 be assured that additional financing will be available on terms favorable to us, or at all. If we issue additional equity or convertible debt securities, our existing stockholders may experience substantial dilution.

Off-Balance Sheet Arrangements

We do not have any off-balance
sheet arrangements as defined in Regulation S-K Items 303(a)(4), investments in special-purpose entities or undisclosed borrowings or debt. Additionally, we are not a party to any derivative contracts or synthetic leases.

Contractual Obligations and Commercial Commitments

In comparison
with our Annual Report on Form 10-K for the year ended December 31, 2005, we believe that there have been no significant changes in contractual obligations or commercial commitments.



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

Interest Rate Risk

Our exposure to market risk for interest rate changes relates primarily to our short-term and long-term investments. We
had no derivative financial instruments as of June 30, 2006 or December 31, 2005. We invest our excess cash in debt and equity instruments of high-quality corporate issuers with original maturities greater than three months and effective
maturities less than two years. The amount of credit exposure to any one issue, issuer and type of instrument is limited. These securities are subject to interest rate risk and vary in value as market interest



22



---

##### Table of Contents

rates fluctuate. During the three and six months ended June 30, 2006, the effects of changes in interest rates on the fair market value of our
marketable investment securities and our earnings were not material. Further, we believe that the impact on the fair market value of our securities and our earnings from a hypothetical 10% change in interest rates would not be significant.



|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 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. During the period covered by this report, there were no changes in the Companys internal control over
financial reporting that have materially affected, or could be reasonably likely to materially affect, the registrants internal control over financial reporting.During the course of our general evaluation of our internal controls and
our fiscal 2005 close process, four significant deficiencies in the design and operation of our internal controls were identified. We have taken steps to remediate these significant deficiencies during the first half of 2006; however, the external
testing of the effectiveness of our remediation efforts has not been completed as of June 30, 2006.

(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.



23



---

##### Table of Contents

PART II. OTHER INFORMATION



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

Cisneros v.
Yahoo! Inc

On August 3, 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 us, 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 also filed a motion for preliminary injunction
on August 3, 2004.

On January 3, 2005, we filed a demurrer to the complaint, which was overruled on January 27, 2005. On January 3,
2005, we also filed a motion to strike certain allegations regarding claims for restitution, which was denied in part and granted in part on May 9, 2005. We filed an answer to the complaint on February 28, 2005, consisting of a general
denial of all allegations. On October 11, 2005, the court conducted a trial on two of our affirmative defenses. The court held that California public policy bars the plaintiffs from receiving a portion of their requested damages.

On December 2, 2005, plaintiffs filed a renewed motion for a preliminary injunction. We filed our response on February 27, 2006. The Court has not yet
scheduled a hearing for plaintiffs renewed motion. The court has allowed certain discovery to proceed with respect to plaintiffs renewed motion. On or about April 3, 2006, plaintiffs filed a Motion to Amend their Complaint to Add
Additional Plaintiffs. The Defendants filed their Opposition to the Motion on May 1, 2006. On or about May 23, 2006, plaintiffs were granted leave to amend their complaint to name additional plaintiffs. The Court has set a case management
conference for August 28, 2006, and has indicated it will set a briefing and hearing schedule for plaintiffs renewed motion for a preliminary injunction at that time.

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

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

On March 30, 2005 the case was removed to United States District Court for the Western District of Arkansas. On April 4, 2005 plaintiffs U.S. Citizens for Fair
Credit Card Terms, Inc. and Savings 4 Merchants, Inc. filed a motion of voluntary dismissal without prejudice. The motion was granted on April 7, 2005. Plaintiffs Lanes Gifts and Collectibles, L.L.C. and Max Caulfield d/b/a Caulfield
Investigations filed a motion to remand the case to state court on April 13, 2005, which was granted in June 2005. In July 2005, defendants, including us, petitioned the Eighth Circuit Court of Appeals for an appeal of the remand order, and
moved to stay the proceedings while the appeal is pending. The petition was denied on September 8, 2005 and the case was remanded to the Circuit Court of Miller County, Arkansas. We were served with discovery requests on October 7, 2005.
We filed and/or joined motions to dismiss on the basis of failure to state a claim upon which relief can be granted, lack of personal jurisdiction, and improper venue. Pursuant to the courts initial scheduling order, plaintiffs had until
January 27, 2006 to respond to the motions to dismiss for lack of personal jurisdiction and improper venue; and until June 9, 2006 to respond to the motion to dismiss on the basis of failure to state a claim upon which relief can be
granted. However the court entered an order staying all proceedings for a period of 60 days on January 9, 2006. On March 8, 2006, the Court entered an order extending the stay until March 31, 2006. On April 1, 2006, the Court
further extended the stay until April 20, 2006. On April 20, 2006 the Court preliminarily approved a class settlement among plaintiffs, defendant Google, Inc., and certain defendants who display Google advertisements on their networks (the
Google Settlement). The Google Settlement purports to release Google of all claims and also purports to release certain defendants, including us, for any claims associated with the display of Google advertisements on their networks. On
April 21, 2006, the Court ordered the remaining defendants, including us, to mediation and further stayed the proceedings to June 21, 2006. The Court further extended the Stay as to us until August 16, 2006. On July 24 and 25,
2006, the Court had a final settlement hearing on the Google Settlement, and on July 26, 2006 the Court approved the settlement.

Additionally, we are
involved, from time to time, in various legal proceedings arising from the normal course of business activities. Although the results of litigation and claims cannot be predicted with certainty, we do not expect resolution of these matters to have a
material adverse impact on our consolidated results of operations, cash flows or financial position. However, an unfavorable resolution of a matter could, depending on its amount and timing, materially affect our future results of operations, cash
flows or financial position in a future period. Regardless of the outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

Other than the addition of a risk factor regarding
our reliance on AdCenter for Publisher customers for generation of paid clicks, as set forth below, there have been no material changes to the risk factors that are included in our Annual Report on Form 10-K for the year ended December 31, 2005
that could affect our business, results of operations or financial condition.



24



---

##### Table of Contents

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

Risks Related to our Business

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

The display of listings advertisements
accounted for substantially all of our revenue for the three and six months ended June 30, 2006. Our success depends upon advertisers choosing to use, and distribution network partners choosing to distribute, our listings products. Advertisers
and distribution network partners may not adopt our listings products at projected rates, or changes in market conditions may adversely affect the use or distribution of listings advertisements. Because of our revenue concentration in the online
advertising business, such shortfalls or changes could have a negative impact on our financial results. Also, many of our products are offered to website publishers who use them to display or generate revenue from their online advertisements. If we
are unable to generate significant revenue from our online advertising business, or if market conditions adversely affect the use or distribution of online advertisements generally, our results of operations, financial condition and/or liquidity
will suffer.

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

The success of our online advertisement products depends in large part on the size and
quality of our distribution network. We may be unable to maintain or add distribution network partners of satisfactory quality in our distribution network at reasonable revenue-sharing rates, or at all. Our distribution network is concentrated, with
our two largest distribution network partners accounting for approximately 30% and 25% of our revenue for the three and six months ended June 30, 2006. If we lose any significant portion of our distribution network, we would need to find
alternative sources of quality click traffic to replace the lost paid clicks. In the past, we have lost portions of our distribution network, such as when our contract with Microsofts MSN expired in the first quarter of 2004. Although
alternate sources of click traffic are currently available in the market, they may not be available at reasonable prices, they will likely be subject to competition from various paid search providers, and they may be of lower quality. There is
fierce competition among search providers to sign agreements with traffic providers. We may be unable to negotiate and sign agreements with quality traffic providers on favorable terms, if at all. If we are unsuccessful in maintaining and expanding
our distribution network, then our ability to generate revenue may be seriously harmed.

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

The
success of our Company depends in large part on our ability to sign and maintain license and revenue share arrangements with our AdCenter for Publisher customers. We may be unable to maintain or add AdCenter for Publisher customers of satisfactory
quality at reasonable revenue-sharing rates, or at all. Our overall revenue is concentrated, with one AdCenter for Publisher customer accounting for approximately 12% of our revenue for the three and six months ended June 30, 2006. If we lose
this AdCenter for Publisher customer, we would need to find alternative sources of revenue to replace the lost revenue share on paid clicks. Other publishers who become our customers may not be available at reasonable revenue share rates, they will
likely be subject to competition from various other online advertising service providers, and they have smaller audiences or viewers that respond less to online advertisements. If we are unable to maintain or generate new AdCenter for Publisher
arrangements, then our ability to generate revenue may be seriously harmed.

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

We had a net loss of approximately $4.4 million and $8.9 million for the three and six months ended June 30, 2006 and as of June 30, 2006 our accumulated deficit was approximately $212.7 million. We may be
unable to achieve profitability in the foreseeable future and, if we regain profitability, we may be unable to maintain it. Our ability to achieve and maintain profitability will depend on our ability to generate additional revenue and contain our
expenses. In order to generate additional revenue, we will need to expand our network of distribution network partners, expand our proprietary traffic sources such as our owned-and-operated websites, offer our publisher products to publisher
customers and expand our advertiser base. We may be unable to accomplish some or any of these goals because of the risks identified in this report or for unforeseen reasons. Also, we may be unable to contain our costs due to the need to make revenue
sharing payments to our distribution network partners, to invest in product development, 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 profitability in the future, which could result in a decline in our stock price.



25



---

##### Table of Contents

If we experience downward pressure on our revenue per click or we are unable to improve our revenue per click, our
financial results will suffer

We have experienced, and may in the future experience, downward pressure on our average revenue per click due to various
factors. In the three months ended June 30, 2006, for example, our average revenue per click decreased compared to the three months ended June 30, 2005. We may experience decreases in revenue per click 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 falls for any reason, or if we are unable to
grow our revenue per click, 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 falls, our financial results will suffer

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

Our growth depends upon our ability to retain and grow our audience for our vertical search sites, and there are risks associated with introducing new products and
services

To maintain and grow our revenue, part of our strategy is to increase the amount, frequency and page views by consumers of our 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 recently began owning and operating our own websites, and 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. Also, if
we do not improve and enhance our vertical search sites in a timely manner, we may lose existing customers to our competitors or fail to attract new customers, which may adversely affect our performance and results of operations.

If we are unable to license or acquire compelling content at reasonable costs, we may be unable to increase traffic to and revenue of our vertical search sites

Our future success depends in part upon our ability to aggregate compelling content and search results and deliver them through our online
properties. We license much of the content on our online properties, such as journal articles and news items, from third parties. Our ability to maintain and build relationships with third-party content providers will be important for our
success. Also, as competition for compelling content increases both domestically and internationally, our content providers may increase the prices at which they offer their content to us and potential content providers may not offer their
content on terms agreeable to us. An increase in the prices charged to us by third-party content providers could harm our operating results and financial condition. If we are unable to license or acquire compelling content at reasonable
prices, if other companies broadcast content that is similar to or the same as that provided by us, the number of consumers of our services may not grow at all or may grow at a slower rate than anticipated, which could harm our operating results.

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

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

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

The Internet search industry is rapidly evolving and very turbulent, and we will need to continue developing new and upgraded products and services,
adapt to new business environments and competition, 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 face
platform and resource constraints that prevent us from developing upgraded products and services. We may fail to successfully identify new products or services, or fail to bring new products or services to market in a timely and efficient manner.
Rapid industry change makes it difficult for us to forecast our results accurately, particularly over longer periods. We face the



26



---

##### Table of Contents

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, which could have an adverse effect on our business and results of operations.

We face intense 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. 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. We also compete for distribution
network partners and for ad placement on those partners sites on the basis of the relevance of our search results and the price per click charged to advertisers. We also experience competition for our owned-and-operated websites and for
offering our technology to website publishers. Some of our competitors have larger distribution networks and proprietary traffic bases, longer operating histories, greater brand recognition higher price per clicks, better relevance and conversion
rates, or better products and services than we have.

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

From time to time we evaluate corporate development opportunities, and when appropriate, we intend to make
acquisitions of, or significant investments in, complementary companies or technologies to increase our technological capabilities 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, record impairment of goodwill in connection with future or past acquisitions, or
divest non-performing assets at below-market prices, which would adversely affect our operating results.

We have acquired businesses and technologies in
recent years, including the acquisition of Net Nanny from BioNet Systems, LLC in the second quarter of 2004 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 offer to end users certain software we
acquired, 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

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

Our success
depends on our ability to identify, attract, retain and motivate highly skilled development, technical, sales, and management personnel. We have a limited number of key development, technical, sales and management personnel performing critical
company functions, and the loss of the services of any of our key employees, particularly any of our executive team members or key technical personnel, could adversely affect our business. In recent years, we have experienced significant turnover in
our management team. For example, our Chief Financial Officer joined us in November 2005. Other members of management have also joined us in the last year, and the management team as a whole has had only a limited time to work together. We cannot
assure you that we will be able to retain our key employees or that we can identify attract and retain highly skilled personnel in the future.

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

We use proprietary and licensed software and databases to crawl the web and index web pages, create, edit and serve advertisements, compile and distribute our search results, track paid clicks, bid on, rank and manage advertisements 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. Developments, such as the following developments, may strain our capacity and result in
technical difficulties with our web site or the web sites of our distribution network partners:



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



| |  |  | substantial increases in the number of queries to our databases
| | - |  | ---------------------------------------------------------------



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



| |  |  | the addition of new products or new features or changes to our products
| | - |  | -----------------------------------------------------------------------

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



27



---

##### Table of Contents

Risks Related to Operating in our Industry

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

Invalid clicks, most often due to click fraud, are an ongoing problem for the Internet advertising industry, and we are exposed to the risk of invalid clicks
on our paid listings. Invalid clicks occur when a person or robotic software causes a click on a paid listing to occur for some reason other than to view the underlying content. We invest significant time and resources in preventing, detecting and
eliminating invalid traffic from our distribution network. However, the perpetrators of click fraud have developed sophisticated methods to evade detection, and we are unlikely to detect and remove all invalid traffic from our search network. We are
subject to advertiser complaints and litigation regarding invalid clicks, and we may be subject to advertiser complaints, claims, litigation or inquiries in the future. We have from time to time credited invoices or refunded revenue to our customers
due to suspicious traffic, and we expect to continue to do so in the future. If our systems to detect invalid traffic are insufficient, or if we find new evidence of past invalid clicks, we may have to issue credits or refunds retroactively to our
advertisers, and we may still have to pay revenue share to our distribution network partners. This could negatively affect our profitability and hurt our brand. If traffic consisting of invalid clicks is not detected and removed from our search
network, the affected advertisers may experience a reduced return on their investment in our online advertising because the invalid clicks will not lead to actual sales for the advertisers. This could lead the advertisers to become dissatisfied with
our products, which could lead to loss of advertisers and revenue and could materially and adversely affect our financial results.

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

Any system failure that interrupts our hosted products or
services, including our search service, whether caused by computer viruses, software failure, power interruptions, intruders and hackers, or other causes, could harm our financial results. For example, our system for tracking and invoicing clicks is
dependent upon a proprietary software platform. If we lose key personnel or experience a failure of software, this system may fail. In such event, we may be unable to track paid clicks and invoice our customers, which would materially and adversely
affect our financial results and business reputation.

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

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

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

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



28



---

##### Table of Contents

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 revenue and business. For any of the foregoing reasons, litigation involving our listings business and technology could have a material adverse effect on our business, operating results and financial
condition.

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

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

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

New lawsuits, laws, regulations and enforcement actions applicable to the online industry may limit the delivery, appearance and
content of our advertising or websites 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 consumers and issued guidance on what disclosures are necessary to avoid misleading consumers about the possible effects of paid placement or paid inclusion listings on the search results. In 2003, the United States Department of Justice
issued statements indicating its belief that displaying advertisements for online gambling might be construed as aiding and abetting an illegal activity under federal law. In 2004, the United States Congress considered new laws regarding sale of
pharmaceutical products over the Internet and the use of adware to distribute advertisements on the Internet, 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.

In addition, legislation or regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002 (Section
404), present ongoing compliance risks, and a failure to comply with these new laws and regulations could materially harm our business. For example, in the course of our general evaluation of our internal controls we identified certain
deficiencies in the design and operation of such controls. We continue the process of remediating such deficiencies. It is possible that as we continue our Section 404 compliance efforts we will identify significant deficiencies, or material
weaknesses, in the design and operation of our internal controls. We may be unable to remediate any of these matters in a timely fashion, and/or our independent registered public accounting firm may not agree with our remediation efforts in
connection with their Section 404 attestation. Such failures could impact our ability to record, process, summarize and report financial information, and could impact market perception of the quality of our financial reporting, which could
adversely affect our business and our stock price.

Privacy-related regulation of the Internet could limit the ways we currently collect and use
personal information, which could decrease our advertising revenue 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 consumers may affect the way in which we collect and use personal information. We could
incur additional expenses if new laws or court judgments, in the United States or abroad, regarding the use of personal information are introduced or if any agency chooses to investigate our privacy practices.

Our 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 consumers with a particular advertisement, to limit the number of times a user is shown



29



---

##### Table of Contents

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

We and some of our distribution network partners or advertisers retain information about our consumers. If others were able to penetrate the network security of these
user databases and access or misappropriate this information, we and our distribution network partners or advertisers could be subject to liability. These claims may result in litigation, our involvement in which, regardless of the outcome, could
require us to expend significant time and financial resources.

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

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

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

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

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

Risks Related to Accounting Matters

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

As described in Note 1 (Summary of Significant Accounting Policies) to the Unaudited Condensed Consolidated
Financial Statements in this report, we adopted SFAS 123R starting January 1, 2006. Under SFAS 123R, we are required to account for the fair value of stock options granted to employees as compensation expense, which is likely to have a
significant adverse impact on our GAAP results of operations and net income (loss) per share. If we reduce or alter our use of share-based compensation to minimize the recognition of these expenses, our ability to recruit, motivate and retain
employees may be impaired, which could put us at a competitive disadvantage in the marketplace. In order to prevent any net decrease in their overall compensation packages, we might decide to make corresponding increases in the cash compensation we
pay to current and prospective new employees. An increase in employee wages and salaries would diminish our cash available for marketing, product development and other uses and might adversely impact our GAAP results of operations. Any of these
effects might cause the market price of our stock to decline, particularly if investors conclude that any resulting decrease in reported profits in 2006 was caused by operational problems rather than by accounting rule changes.

Risks Related to the Capital Market

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

Our revenue 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 network partners, or changes in the implementation of search results on partner web sites,
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



30



---

##### Table of Contents

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



| |  |  | changes in the amount, frequency and page views by consumers of our vertical search sites,
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | 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 Ad Center, our web site or the web sites of our distribution network partners, or
| | - |  | ---------------------------------------------------------------------------------------------------------



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

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

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

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

Our stock price may fluctuate, and you may not be able to sell your shares for a profit, as a result of a number of factors including:



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



| |  |  | quarterly fluctuations in our operating results,
| | - |  | ------------------------------------------------



| |  |  | the termination or expiration of our distribution agreements,
| | - |  | -------------------------------------------------------------



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



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



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



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



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



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



| |  |  | the exchange by Chess Depositary Interest (CDI) holders of CDIs for shares of common stock at a ratio of 1:1, and resale of such shares in the Nasdaq National Market (as of August
7, 2006, the CDIs registered for trading on the Australian Stock Exchange were exchangeable into an aggregate of approximately 1.68 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, on reasonable terms or at all, our liquidity and results of operations will be
materially and adversely impacted

Although we believe that our working capital will provide adequate liquidity to fund our operations and meet our
other cash requirements for the foreseeable future, unanticipated developments in the short term, such as the entry into agreements that require large cash payments or the



31



---

##### Table of Contents

acquisition of businesses with negative cash flows, may necessitate additional financing. We may seek to raise additional capital through public or private
debt or equity financings in order to:



| |  |  | fund the additional operations and capital expenditures,
| | - |  | --------------------------------------------------------



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



| |  |  | develop and upgrade our technology infrastructure beyond current plans,
| | - |  | -----------------------------------------------------------------------



| |  |  | develop new product and service offerings,
| | - |  | ------------------------------------------



| |  |  | take advantage of favorable conditions in capital markets, or
| | - |  | -------------------------------------------------------------



| |  |  | respond to competitive pressures.
| | - |  | ---------------------------------

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

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 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
|------- | ----------------------------------------------------

On June
14, 2006, we held our annual stockholder meeting. At the meeting, a quorum of our stockholders considered a proposal to re-elect David B. Hills and Gary A. Wetsel to the Board of Directors. The following votes were cast by
stockholders:



|               |  |            |  |          
|-------------- |  | ---------- |  | ---------
|For            |  | Withheld   |  | Abstain  
|David B. Hills |  | 18,921,268 |  | 138,740  
|Gary A. Wetsel |  | 17,453,128 |  | 1,606,880

At the same meeting, the stockholders also considered a proposal to ratify the Boards selection of
PricewaterhouseCoopers, LLP as the Companys independent registered public accounting firm for the fiscal year ending December 31, 2006. The following votes were cast by stockholders:



|           |  |         |  |        
|---------- |  | ------- |  | -------
|For        |  | Against |  | Abstain
|18,958,116 |  | 82,932  |  | 18,960 



|ITEM 5. | OTHER INFORMATION.
|------- | ------------------

None



|ITEM 6. | EXHIBITS
|------- | --------

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



32



---

##### Table of Contents

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/ JOHN SIMONELLI                          
|                |  | John Simonelli, Chief Financial Officer     
|                |  | (Principal Financial and Accounting Officer)



33



---

##### Table of Contents

EXHIBIT INDEX



|               |  |                                                                                                                                                                                                                                                                                                                
|-------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description of Document                                                                                                                                                                                                                                                                                        
|               | 
|3.1            |  | Restated Certificate of Incorporation (Filed with the Companys Quarterly Report on Form 10-Q filed with the SEC on November 14, 2005).                                                                                                                                                                        
|               | 
|3.2            |  | Bylaws (Filed with the Companys Quarterly Report on Form 10-Q filed with the SEC on August 14, 2000).                                                                                                                                                                                                         
|               | 
|4.1            |  | Form of Specimen Stock Certificate (Filed with the Companys Quarterly Report on Form 10-Q filed with the SEC on November 14, 2005).                                                                                                                                                                           
|               | 
|4.2            |  | Forms of Stock Option Agreement used by the Registrant in connection with grants of stock options to employees, directors and other service providers in connection with the Amended and
Restated 1998 Stock Plan (Filed with the Companys Current Report on Form 8-K filed with the SEC on October 22, 2004).
|               | 
|4.3            |  | Form of cover sheet for use with Stock Option Agreement for grants of stock options to executives in connection with the Companys Executive Team Incentive Plan, Plan Year 2006 (Filed
with the Companys Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006).                                  
|               | 
|10.1           |  | Form of Indemnification Agreement entered into between the Registrant and each of its directors and officers (Filed with the Companys Registration Statement on Form S-1 (File No.
333-80581) filed with the SEC on June 14, 1999).                                                                           
|               | 
|10.2           |  | Amended and Restated 1998 Stock Plan (Filed with the Companys Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999).                                                                                                                                                   
|               | 
|10.3           |  | 1999 Employee Stock Purchase Plan as amended (Filed with the Companys Registration Statement on Form S-8 (File No. 333-129987) filed with the SEC on November 29, 2005).                                                                                                                                      
|               | 
|10.4           |  | LookSmart, Ltd. Executive Team Incentive Plan, Plan Year 2006 (Filed with the Companys Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006).                                                                                                                                                     
|               | 
|10.7           |  | Zeal Media, Inc. 1999 Stock Plan (Filed with the Companys Registration Statement on Form S-8 filed with the SEC on December 7, 2000).                                                                                                                                                                         
|               | 
|10.8           |  | WiseNut, Inc. 1999 Stock Incentive Plan (Filed with the Companys Registration Statement on Form S-8 filed with the SEC on April 18, 2002).                                                                                                                                                                    
|               | 
|10.12          |  | Lease Agreement with Rosenberg SOMA Investments III, LLC for property located at 625 Second Street, San Francisco, California, dated May 5, 1999 (Filed with the Companys Registration
Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999).                                       
|               | 
|10.34+         |  | Co-Location Services Agreement between the Registrant and Savvis Communications Corporation dated February 19, 2004 (Filed with the Companys Quarterly Report on Form 10-Q/A filed with
the SEC on November 7, 2003).                                                                                         
|               | 
|10.35*        |  | Second Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and IAC Search & Media dated May 16, 2006 filed herewith.                                                                                                                                                            
|               | 
|10.35*        |  | Second Addendum to AdCenter License, Hosting, and Support Agreement between the Registrant and IAC Search & Media, dated May 16, 2006.                                                                                                                                                                         
|               | 
|10.37         |  | AdCenter License, Hosting and Support Agreement between the Registrant and Ask Jeeves, Inc. dated May 16, 2005 (Filed with the Companys Quarterly Report on Form 10-Q filed with the SEC
on May 10, 2006).                                                                                                    
|               | 
|10.38         |  | Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and Ask Jeeves, Inc. dated January 20, 2006 (Filed with the Companys Quarterly Report on Form 10-Q
filed with the SEC on May 10, 2006).                                                                                    
|               | 
|10.39         |  | Paid Listings License Agreement between the Registrant and SearchFeed.com dated April 15, 2006 (Filed with the Companys Quarterly Report on Form 10-Q filed with the SEC on May 10,
2006).                                                                                                                    
|               | 
|10.40         |  | License Agreement between the Registrant and SearchFeed.com dated November 23, 2003, as Amended on March 29, 2004 and March 21, 2005 (Filed with the Companys Annual Report on Form 10-K
filed with the SEC on March 15, 2006).                                                                               
|               | 
|10.41          |  | Separation Agreement and General Release between the Registrant and its former General Counsel dated August 20, 2005 (Filed with the Companys Annual Report on Form 10-K filed with the
SEC on March 15, 2006).                                                                                               
|               | 
|10.42         |  | Amendment to the Prioritized Listings Syndication Agreement between the Registrant and Interchange Corporation dated as of June 30, 2004 (Filed with the Companys Quarterly Report on
Form 10-Q filed with the SEC on August 9, 2004).                                                                        
|               | 
|10.43          |  | Second Amendment to the Prioritized Listings Syndication Agreement between the Registrant and Interchange Corporation dated as of July 19, 2005 (Filed with the Companys Quarterly Report
on Form 10-Q filed with the SEC on August 9, 2005).                                                                 
|               | 
|10.44          |  | Prioritized Listings Syndication Agreement between the Registrant and ELiberation, Inc., dated as of October 19, 2001. (Filed with the Companys Quarterly Report on Form 10-Q filed
with the SEC on August 9, 2004).                                                                                          



34



---

##### Table of Contents

|       |  |                                                                                                                                                                                                                                  
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|10.45  |  | Employment offer letter between the Registrant and its chief executive officer dated September 24, 2004 (Filed with the Companys Current Report on Form 8-K filed with the SEC on
October 18, 2004).                            
|       | 
|10.46  |  | Letter agreement between the Registrant and its general counsel, dated July 1, 2004 (Filed with the Companys Current Report on Form 8-K filed with the SEC on January 26,
2005).                                                
|       | 
|10.47  |  | Employment offer letter between the Registrant and its senior vice president, consumer products, dated December 23, 2004 (Filed with the Companys Current Report on Form 8-K filed with
the SEC on December 30, 2004).          
|       | 
|10.48  |  | Employment offer letter between the Registrant and its senior vice president, sales, dated November 19, 2004 (Filed with the Companys Current Report on Form 8-K filed with the SEC on
December 14, 2004).                      
|       | 
|10.50  |  | Separation agreement between the Registrant and its former interim chief executive officer, dated November 12, 2004 (Filed with the Companys Current Report on Form 8-K filed with the
SEC on December 14, 2004).               
|       | 
|10.51  |  | Separation agreement between the Registrant and its former vice president, human resources, dated August 3, 2004 (Filed with the Companys Annual Report on Form 10-K filed with the SEC
on March 16, 2005).                     
|       | 
|10.52  |  | Separation agreement between the Registrant and its former senior vice president, product, dated August 8, 2004 (Filed with the Companys Annual Report on Form 10-K filed with the SEC on
March 16, 2005).                      
|       | 
|10.53+ |  | Prioritized Listings Syndication Agreement between the Registrant and Search123, Inc. dated August 21, 2001 (Filed with the Companys Annual Report on Form 10-K filed with the SEC on
March 16, 2005).                          
|       | 
|10.54+ |  | Amendment No. 2 to the Prioritized Listings Syndication Agreement between the Registrant and Search123, Inc. dated February 8, 2005. (Filed with the Companys Quarterly Report on Form
10-Q filed with the SEC on May 10, 2005).
|       | 
|10.55  |  | Amendment No. 3 to the Prioritized Listings Syndication Agreement between the Registrant and Search123, Inc. dated June 24, 2005 (Filed with the Companys Quarterly Report on Form 10-Q
filed with the SEC on August 9, 2005).  
|       | 
|10.56  |  | Employment offer letter between the Registrant and its Senior Vice President, Business Development dated April 18, 2005 (Filed with the Companys Current Report on Form 8-K filed with
the SEC on April 19, 2005).              
|       | 
|10.57  |  | Employment offer letter between the Registrant and its Senior Vice President and Chief Technology Officer dated April 18, 2005 (Filed with the Companys Current Report on Form 8-K filed
with the SEC on April 19, 2005).       
|       | 
|10.58  |  | Amendment to employment offer letter between the Registrant and its Chief Executive Officer dated June 21, 2005 (Filed with the Companys Current Report on Form 8-K filed with the SEC on
June 21, 2005).                       
|       | 
|10.59  |  | Employment offer letter between the Registrant and its General Counsel and Senior Vice President dated as of July 11, 2005 (Filed with the Companys Current Report on Form 8-K filed with
the SEC on July 14, 2005).            
|       | 
|10.60  |  | Employment offer letter between the Registrant and its Vice President, Publisher Products dated as of August 8, 2005 (Filed with the Companys Current Report on Form 8-K filed with the
SEC on August 10, 2005).                
|       | 
|10.61  |  | Employment offer letter between the Registrant and its Chief Financial Officer dated October 20, 2005 (Filed with the Companys Current Report on Form 8-K filed with the SEC on October
24, 2005).                              
|       | 
|10.62  |  | Employment offer letter between the Registrant and its Vice President, Marketing dated as of December 4, 2005 (Filed with the Companys Current Report on Form 8-K filed with the SEC on
December 23, 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                                                                                                   

---

|(*) | Filed herewith
|--- | --------------



|() | Material in the exhibit marked with a  has been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission. Omitted
portions have been filed separately with the Securities and Exchange Commission.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



35