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**UNITED STATES OF AMERICA**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

**x********            ********QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2008**

 

**o********            ********TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the transition period from       to      **

 

**Commission File Number: 001-32255**

 

**ANSWERSCORPORATION**

(Exactname of Registrant as specified in its charter)

 

| **Delaware**                                                   |       | **98-0202855**                       |
|----------------------------------------------------------------|------------|--------------------------------------|
| (State or Other Jurisdiction of Incorporation or Organization) |       | (I.R.S. Employer Identification No.) |
|                                                           |       |                                 |
| **237 West 35th Street, Suite 1101,  New York, New York** | ** ** | **10001**                            |
| (Address of principal executive offices)                       |       | (Zip Code)                           |

 

**(646) 502-4777**

(Registrant’s telephone number)

 

 

(Former Name, Former Address and Former Fiscal Year, if changed sincelast report)

 

Indicate by check mark whetherthe registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

 

Yes   x                     No   o

 

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company. See the definitions of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

Largeaccelerated Filer   o         Acceleratedfiler   x         Non-acceleratedfiler   o

 

Smallerreporting company   o

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

 

Yes   o                     No   x

 

The number of the registrant’sshares of common stock outstanding was 7,870,538 as of November 5, 2008.

 

 

 

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**ANSWERS CORPORATION**

 

**FORM 10-Q**

 

**CONTENTS**

 
| ** PART I —  FINANCIAL INFORMATION** |                                                                                                        |
|-----------------------------------------------------|-------------------------------------------------------------------------------------------------------------|
|                                                |                                                                                                        |
| Item 1.                                             | Consolidated Financial Statements (unaudited)                                                               | 4 |
|                                                |                                                                                                        |   |
|                                                | Consolidated Balance Sheets as of September 30,  2008 and December 31, 2007                       | 4 |
|                                                |                                                                                                        |   |
|                                                | Consolidated Statements of Operations for the three  and nine months ended September 30, 2008 and 2007 | 5 |
|                                                |                                                                                                        |   |
|                                                | Consolidated Statements of Cash Flows for the nine  months ended September 30, 2008 and 2007           | 6 |
|                                                |                                                                                                        |   |
|                                                | Notes to Consolidated Financial Statements                                                                  | 7 |
|                                                |                                                                                                        |   |
| Item  2.                                            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                 | 20 |
|                                                |                                                                                                        |   |
| Item  3.                                            | Quantitative  and Qualitative Disclosures About Market Risk                                                 | 37 |
|                                                |                                                                                                        |   |
| Item  4.                                            | Controls  and Procedures                                                                                    | 37 |
| ** **                                          | ** **                                                                                                  | ** ** |
| **PART II  — OTHER INFORMATION**          |                                                                                                        |
|                                                |                                                                                                        |   |
| Item 1.                                             | Legal  Proceedings                                                                                          | 38 |
|                                                |                                                                                                        |   |
| Item 1A.                                            | Risk Factors                                                                                                | 38 |
|                                                |                                                                                                        |   |
| Item  2.                                            | Unregistered  Sales of Equity Securities and Use of Proceeds                                                | 48 |
|                                                |                                                                                                        |   |
| Item  3.                                            | Defaults  Upon Senior Securities                                                                            | 48 |
|                                                |                                                                                                        |   |
| Item  4.                                            | Submission  of Matters to a Vote of Security Holders                                                        | 48 |
|                                                |                                                                                                        |   |
| Item 5.                                             | Other  Information                                                                                          | 49 |
|                                                |                                                                                                        |   |
| Item 6.                                             | Exhibits                                                                                                    | 49 |
|                                                |                                                                                                        |   |
| Signatures                                          |                                                                                                        |

 

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**INTRODUCTORY NOTE**

 

**This Reporton Form 10-Q for Answers Corporation (“Answers” or the “Company”)may contain forward-looking statements. You can identify these statementsby forward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,”believe,” “estimate” and “continue” or similar words. Forward-lookingstatements include information concerning possible or assumed future businesssuccess or financial results. You should read statements that contain thesewords carefully because they discuss future expectations and plans, whichcontain projections of future results of operations or financial condition orstate other forward-looking information.  We believe that it is importantto communicate future expectations to investors. The forward-looking statementsincluded herein are based on current expectations that involve a number ofrisks and uncertainties, which are discussed in Item 1A, “Risk Factors”and in other sections of this Form 10-Q and in our other filings with theSecurities and Exchange Commission. These risks and uncertainties could cause actual results or events todiffer materially from the forward-looking statements that we make**.

 

**Although,there may be events in the future that we are not able to accuratelypredict or control, we do not undertake any obligation to update anyforward-looking statements for any reason, even if new information becomesavailable or other events occur in the future.**  **Accordingly, to the extent that this Form 10-Q containsforward-looking statements regarding the financial condition, operatingresults, business prospects or any other aspect of the Company, please beadvised that Answers’ actual financial condition, operating results andbusiness performance may differ materially from that projected orestimated by the Company in forward-looking statements.**

 

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**PART I - FINANCIAL INFORMATION**

 

Answers Corporation and Subsidiary

 

**Consolidated Balance Sheets(unaudited, in thousands except share and per share data)**

** **
| ** **                                                                                                                                                                                                                                                                                                          | ** ** | **September 30** | ** ** | **December 31** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                          | ** ** | **2008**              | ** ** | **2007**             | ** ** |
| ** **                                                                                                                                                                                                                                                                                                          | ** ** | **$**                 | ** ** | **$**                | ** ** |
| **Assets**                                                                                                                                                                                                                                                                                                          |       |                  | ** ** |                 |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Current assets:**                                                                                                                                                                                                                                                                                                 |       |                  | ** ** |                 |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                           | ** ** | **9,653**             | ** ** | 6,778                |       |
| Investment securities                                                                                                                                                                                                                                                                                               | ** ** | **—**            | ** ** | 700                  |       |
| Accounts receivable                                                                                                                                                                                                                                                                                                 | ** ** | **1,786**             | ** ** | 1,448                |       |
| Prepaid expenses and other  current assets                                                                                                                                                                                                                                                                          | ** ** | **847**               | ** ** | 487                  |       |
| **Total current assets**                                                                                                                                                                                                                                                                                            | ** ** | **12,286**            | ** ** | 9,413                |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Long-term deposits  (restricted)**                                                                                                                                                                                                                                                                                | ** ** | **225**               | ** ** | 196                  |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Deposits in respect of  employee severance obligations**                                                                                                                                                                                                                                                          | ** ** | **1,430**             | ** ** | 1,232                |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Property and  equipment,** net  of $1,916 and $1,615 accumulated depreciation as of September 30, 2008 and December 31,  2007, respectively                                                                                                                                                             | ** ** | **1,175**             | ** ** | 1,012                |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Other assets:**                                                                                                                                                                                                                                                                                                   |       |                  | ** ** |                 |       |
| Intangible assets, net of $610  and $2,352 accumulated amortization as of September 30, 2008and December 31, 2007,  respectively                                                                                                                                                                          | ** ** | **1,055**             | ** ** | 4,766                |       |
| Goodwill                                                                                                                                                                                                                                                                                                            | ** ** | **437**               | ** ** | 437                  |       |
| Prepaid expenses, long-term, and  other assets                                                                                                                                                                                                                                                                      | ** ** | **274**               | ** ** | 275                  |       |
| Deferred charges (Lexico  acquisition and public offering)                                                                                                                                                                                                                                                          | ** ** | **—**            | ** ** | 1,267                |       |
| **Total other assets**                                                                                                                                                                                                                                                                                              | ** ** | **1,766**             | ** ** | 6,745                |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Total assets**                                                                                                                                                                                                                                                                                                    | ** ** | **16,882**            | ** ** | 18,598               |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Liabilities and stockholders’  equity**                                                                                                                                                                                                                                                                      |       |                  | ** ** |                 |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Current liabilities:**                                                                                                                                                                                                                                                                                            |       |                  | ** ** |                 |       |
| Accounts payable                                                                                                                                                                                                                                                                                                    | ** ** | **364**               | ** ** | 968                  |       |
| Accrued expenses                                                                                                                                                                                                                                                                                                    | ** ** | **717**               | ** ** | 1,045                |       |
| Accrued compensation                                                                                                                                                                                                                                                                                                | ** ** | **491**               | ** ** | 551                  |       |
| Warrant to purchase units of  Series B preferred stock and warrants                                                                                                                                                                                                                                            | ** ** | **5,567**             | ** ** | **—**           | ** ** |
| Capital lease obligation –  current portion                                                                                                                                                                                                                                                                    | ** ** | **77**                | ** ** | **—**           | ** ** |
| Deferred revenues                                                                                                                                                                                                                                                                                                   | ** ** | **22**                | ** ** | 16                   |       |
| **Total current liabilities**                                                                                                                                                                                                                                                                                       | ** ** | **7,238**             | ** ** | 2,580                |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Long-term liabilities:**                                                                                                                                                                                                                                                                                          |       |                  | ** ** |                 |       |
| Liability in respect of employee  severance obligations                                                                                                                                                                                                                                                             | ** ** | **1,622**             | ** ** | 1,233                |       |
| Capital lease obligation, net of  current portion                                                                                                                                                                                                                                                                   | ** ** | **126**               | ** ** | **—**           | ** ** |
| Deferred tax liability                                                                                                                                                                                                                                                                                              | ** ** | **23**                | ** ** | 14                   |       |
| **Total long-term liabilities**                                                                                                                                                                                                                                                                                     | ** ** | **1,771**             | ** ** | 1,247                |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Commitments and contingencies**                                                                                                                                                                                                                                                                                   |       |                  | ** ** |                 |       |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Series A  convertible preferred stock:******$0.01 par value;  stated value and liquidation preference of $100 per share; 6% cumulative annual dividend; 60,000 and 0 shares  authorized, 60,000 and 0 shares  issued and outstanding as of September 30, 2008 and December 31,  2007, respectively | ** ** | **385**               | ** ** | **—**           | ** ** |
|                                                                                                                                                                                                                                                                                                                |       |                  | ** ** |                 |       |
| **Stockholders’ equity:**                                                                                                                                                                                                                                                                                      |       |                  | ** ** |                 |       |
| Preferred stock: $0.01 par value;  940,000 shares authorized, none issued                                                                                                                                                                                                                                           | ** ** | **—**            | ** ** | —               |       |
| Common stock; $0.001 par value;  100,000,000 and 30,000,000 shares authorized, 7,870,538 and 7,859,890 sharesissued and outstanding as of  September 30, 2008 and December 31, 2007, respectively                                                                                                         | ** ** | **8**                 | ** ** | 8                    |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                          | ** ** | **77,014**            | ** ** | 73,893               |       |
| Accumulated other comprehensive  loss                                                                                                                                                                                                                                                                               | ** ** | **(27**               | **)**      | (28                  | )          |
| Accumulated deficit                                                                                                                                                                                                                                                                                                 | ** ** | **(69,507**           | **)**      | (59,102              | )          |
| **Total stockholders’ equity**                                                                                                                                                                                                                                                                                 | ** ** | **7,488**             | ** ** | 14,771               |       |
| ** **                                                                                                                                                                                                                                                                                                          | ** ** | ** **            | ** ** |                 |       |
| **Total liabilities and  stockholders’ equity**                                                                                                                                                                                                                                                                | ** ** | **16,882**            | ** ** | 18,598               |       |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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Answers Corporation and Subsidiary

 

**Consolidated Statements of Operations(unaudited, in thousands except share and per share data)**

** **
| ** **                                                                                                             | ** ** | **Three months ended September 30** | ** ** | **Nine months ended September 30** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2008**                                                | ** ** | **2007**                                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                                             | ** ** | **$**                                                   | ** ** | **$**                                                  | ** ** | **$** | ** ** | **$** | ** ** |
|                                                                                                                   |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| **Revenues:**                                                                                                          |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| Advertising revenue                                                                                                    | ** ** | **3,539**                                               | ** ** | 2,165                                                  | ** ** | **9,536** | ** ** | 7,777 |   |
| Answers service licensing                                                                                              | ** ** | **24**                                                  | ** ** | 43                                                     | ** ** | **61** | ** ** | 202 |   |
| Subscriptions                                                                                                          | ** ** | **—**                                              | ** ** | —                                                 | ** ** | **—** | ** ** | 425 |   |
| ** **                                                                                                             |       | **3,563**                                               | ** ** | 2,208                                                  | ** ** | **9,597** | ** ** | 8,404 |   |
|                                                                                                                   |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| **Costs and expenses:**                                                                                                |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| Cost of revenue                                                                                                        | ** ** | **945**                                                 | ** ** | 1,179                                                  | ** ** | **3,754** | ** ** | 3,643 |   |
| Research and development                                                                                               | ** ** | **866**                                                 | ** ** | 769                                                    | ** ** | **2,670** | ** ** | 2,239 |   |
| Sales and marketing                                                                                                    | ** ** | **563**                                                 | ** ** | 1,221                                                  | ** ** | **2,258** | ** ** | 3,275 |   |
| General and administrative                                                                                             | ** ** | **1,311**                                               | ** ** | 1,058                                                  | ** ** | **3,640** | ** ** | 3,003 |   |
| Write-off of the Brainboost  Answer Engine                                                                             | ** ** | **—**                                              | ** ** | —                                                 | ** ** | **3,138** | ** ** | — |   |
| Termination fees and write-off of  costs relating tothe terminated Lexico acquisition and abandoned follow-on offering | ** ** | **—**                                              | ** ** | —                                                 | ** ** | **2,543** | ** ** | — |   |
| **Total operating expenses**                                                                                           | ** ** | **3,685**                                               | ** ** | 4,227                                                  | ** ** | **18,003** | ** ** | 12,160 |   |
|                                                                                                                   |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| **Operating loss**                                                                                                     | ** ** | **(122**                                                | **)**      | (2,019                                                 | **)**      | **(8,406** | **)** | (3,756 | ) |
|                                                                                                                   |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| Interest (expense) income, net                                                                                         | ** ** | **(43**                                                 | **)**      | 88                                                     | ** ** | **30** | ** ** | 299 |   |
| Other income (expense), net                                                                                            | ** ** | **11**                                                  | ** ** | —                                                 | ** ** | **(38** | **)** | (11 | ) |
| Loss resulting from fair value adjustment of warrant to purchase units of Series B preferred stock and warrants   | ** ** | **(2,056**                                              | **)**      | —                                                 | ** ** | **(2,056** | **)** | — |   |
|                                                                                                                   |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| **Loss before income taxes**                                                                                           | ** ** | **(2,210**                                              | **)**      | (1,931                                                 | **)**      | **(10,470** | **)** | (3,468 | ) |
|                                                                                                                   |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| Income tax benefit (expense)                                                                                           | ** ** | **91**                                                  | ** ** | (19                                                    | **)**      | **65** | ** ** | (33 | ) |
|                                                                                                                   |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| **Net loss**                                                                                                           | ** ** | **(2,119**                                              | **)**      | (1,950                                                 | **)**      | **(10,405** | **)** | (3,501 | ) |
|                                                                                                                   |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| **Basic and diluted net loss  per common share**                                                                       | ** ** | **(0.31**                                               | **)**      | (0.25                                                  | **)**      | **(1.37** | **)** | (0.45 | ) |
|                                                                                                                   |       |                                                    | ** ** |                                                   |       |   | ** ** |   |   |
| **Weighted average shares used  in computing basic****and diluted net loss per common share**                          | ** ** | **7,865,263**                                           | ** ** | 7,854,053                                              | ** ** | **7,861,681** | ** ** | 7,844,900 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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Answers Corporation and Subsidiary

 

**Consolidated Statements ofCash Flows****(unaudited, in thousands)**

 
| ** **                                                                                                                 | ** ** | **Nine months ended September 30** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                                                                 | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| ** **                                                                                                                 | ** ** | **$**                                                  | ** ** | **$** | ** ** |
| **Cash flows from operating  activities:**                                                                                 |       |                                                   | ** ** |   |   |
| **Net loss**                                                                                                               | ** ** | **(10,405**                                            | **)**      | (3,501 | ) |
| **Adjustments to reconcile net  loss to net cash used in operating activities:**                                           |       |                                                   | ** ** |   |   |
| Depreciation and amortization                                                                                              | ** ** | **1,080**                                              | ** ** | 1,356 |   |
| Deposits in respect of employee  severance obligations                                                                     | ** ** | **(198**                                               | **)**      | (196 | ) |
| Increase in liability in respect  of employee severance obligations                                                        | ** ** | **380**                                                | ** ** | 310 |   |
| Stock-based compensation to  employees and directors                                                                       | ** ** | **1,312**                                              | ** ** | 1,698 |   |
| Write-off of the Brainboost  Answers Engine                                                                                | ** ** | **3,138**                                              | ** ** | — |   |
| Write-off of amounts paid in  prior periods, relating to the terminated Lexico acquisitionand abandoned follow-on offering | ** ** | **663**                                                | ** ** | — |   |
| Fair value adjustment of warrant to purchase units of Series B  preferred stock and warrants                          | ** ** | **2,056**                                              | ** ** | — |   |
| Loss on disposal of property and  equipment                                                                                | ** ** | **4**                                                  | ** ** | 3 |   |
| Decrease in deferred tax asset                                                                                             | ** ** | **9**                                                  | ** ** | 33 |   |
| Gains from exchange rate forward  contracts, net                                                                           | ** ** | **(46**                                                | **)**      | (19 | ) |
| Exchange rate losses                                                                                                       | ** ** | **38**                                                 | ** ** | 11 |   |
| **Changes in operating assets  and liabilities:**                                                                          |       |                                                   | ** ** |   |   |
| (Increase) decrease in accounts  receivable                                                                                | ** ** | **(339**                                               | **)**      | 270 |   |
| Decrease (increase) in prepaid  expenses and other assets                                                                  | ** ** | **1**                                                  | ** ** | (29 | ) |
| (Decrease) increase in accounts  payable                                                                                   | ** ** | **(254**                                               | **)**      | 28 |   |
| (Decrease) increase in accrued  expenses and other current liabilities                                                     | ** ** | **(150**                                               | **)**      | 57 |   |
| Increase (decrease) in deferred  revenues                                                                                  | ** ** | **6**                                                  | ** ** | (443 | ) |
| **Net cash used in operating  activities**                                                                                 | ** ** | **(2,705**                                             | **)**      | (422 | ) |
|                                                                                                                       |       |                                                   | ** ** |   |   |
| **Cash flows from investing  activities:**                                                                                 |       |                                                   | ** ** |   |   |
| Capital expenditures                                                                                                       | ** ** | **(435**                                               | **)**      | (515 | ) |
| Increase in long-term deposits                                                                                             | ** ** | **(28**                                                | **)**      | (265 | ) |
| Deferred charges relating to  planned acquisition                                                                          | ** ** | **—**                                             | ** ** | (398 | ) |
| Purchases of investment  securities                                                                                        | ** ** | **—**                                             | ** ** | (4,166 | ) |
| Proceeds from sales of investment  securities                                                                              | ** ** | **700**                                                | ** ** | 6,047 |   |
| **Net cash provided by  investing activities**                                                                             | ** ** | **237**                                                | ** ** | 703 |   |
|                                                                                                                       |       |                                                   | ** ** |   |   |
| **Cash flows from financing  activities:**                                                                                 |       |                                                   | ** ** |   |   |
| Payment of capital lease  obligation                                                                                       | ** ** | **(36**                                                | **)**      | — |   |
| Redpoint financing, net of $620  thousand issuance costs                                                                   | ** ** | **5,380**                                              | ** ** | — |   |
| Stock registration costs                                                                                                   | ** ** | **(47**                                                | **)**      | — |   |
| Deferred charges relating to  planned financing                                                                            | ** ** | **—**                                             | ** ** | (109 | ) |
| Exercise of common stock options                                                                                           | ** ** | **10**                                                 | ** ** | 145 |   |
| **Net cash provided by  financing activities**                                                                             | ** ** | **5,307**                                              | ** ** | 36 |   |
|                                                                                                                       |       |                                                   | ** ** |   |   |
| Effect of exchange rate changes  on cash and cash equivalents                                                              | ** ** | **36**                                                 | ** ** | — |   |
| **Net increase in cash and cash  equivalents**                                                                             | ** ** | **2,875**                                              | ** ** | 317 |   |
|                                                                                                                       |       |                                                   | ** ** |   |   |
| Cash and cash equivalents at  beginning of period                                                                          | ** ** | **6,778**                                              | ** ** | 4,976 |   |
|                                                                                                                       |       |                                                   | ** ** |   |   |
| **Cash and cash equivalents at end of period**                                                                             | ** ** | **9,653**                                              | ** ** | 5,293 |   |
| ** **                                                                                                                 | ** ** | ** **                                             | ** ** |   |   |
| **Supplemental disclosures of cash flow  information:**                                                                    |       |                                                   | ** ** |   |   |
| Income taxes paid                                                                                                          | ** ** | **7**                                                  | ** ** | 6 |   |
|                                                                                                                       |       |                                                   | ** ** |   |   |
| **Non-cash investing activities:**                                                                                         |       |                                                   | ** ** |   |   |
| Acquisition of assets through capital lease  obligation                                                                    | ** ** | **239**                                                | ** ** | — |   |
| Deferred charges relating to planned  acquisition                                                                          | ** ** | **—**                                             | ** ** | 100 |   |
| Unrealized net loss from securities                                                                                        | ** ** | **—**                                             | ** ** | 2 |   |
|                                                                                                                       |       |                                                   | ** ** |   |   |
| **Non-cash financing activities:**                                                                                         |       |                                                   | ** ** |   |   |
| Deferred charges relating to planned  financing                                                                            | ** ** | **—**                                             | ** ** | 275 |   |
| Increase in accrued dividends                                                                                              | ** ** | **106**                                                | ** ** | — |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**ANSWERS CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**Note 1 -Business**

 

Answers Corporation (“the Parent”)was founded as a Texas corporation on December 22, 1998, and reorganizedas a Delaware corporation in April 1999. On December 27, 1998, theParent formed a subsidiary based in Israel (“the Subsidiary”), primarily forthe purpose of providing research and development services to the Parent. TheParent and its wholly owned Subsidiary are collectively referred to as “theCompany.” The Parent is a public company and trades on the Nasdaq CapitalMarket under the symbol “ANSW”.

 

As of September 30, 2008,approximately $446 thousand of the Company’s net assets were located outside ofthe United States.

 

The Company provides answer-basedsearch services to users primarily through its websites, Answers.com andWikiAnswers.com.

 

On June 16, 2008, theCompany raised $6,000,000, before related fees and costs, in a privateplacement offering. See Note 5 for further details.

 

In an effort to improve monetization, in the fourthquarter of 2006, the Company began marketing directly to advertisers andgenerating additional advertising revenue. However, at the end of the secondquarter of 2008, the Company decided to abandon that effort, and by the end ofthe third quarter of 2008, the direct sales staff left the Company. Inconnection with the winding down of this effort, the Company recorded a chargeof $90,000, in the second quarter of 2008, to account for the estimated cost ofterminating certain related service contracts and employment agreements.

 

In the first quarter of2008, the Company’s planned acquisition of Lexico Publishing Group LLC and therelated planned offering of securities were terminated due to unfavorablemarket conditions. As a result, the Company recorded a charge to its statementof operations, amounting to approximately $2.54 million. See Note 10 (g) forfurther details.

 

In the second quarter of 2008, the Company abandonedits use of the Brainboost Answer Engine (see Note 4).

 

**Note 2 -Summary of Significant Accounting Policies**

 

**Basis ofPresentation**

 

The accompanying consolidated financialstatements include the accounts of Answers Corporation and its Subsidiary andare presented in accordance with accounting principles generally accepted inthe United States. All significant intercompany balances and transactions havebeen eliminated in consolidation.

 

The accompanying unaudited consolidatedfinancial statements were prepared in accordance with the instructions for Form 10-Qand, therefore, do not include all disclosures necessary for a completepresentation of financial condition, results of operations, and cash flows inconformity with generally accepted accounting principles. All adjustments,which are, in the opinion of management, of a normal recurring nature and arenecessary for a fair presentation of the interim financial statements, havebeen included. Nevertheless, these financial statements should be read inconjunction with the consolidated financial statements and related notesincluded in the Company’s Annual Report on Form 10-K for the year ended December 31,2007. The results of operations for the three and nine months ended September 30,2008 are not necessarily indicative of the results that may be expected for theentire fiscal year or any other interim period.

 

**Use of Estimates**

 

The preparation of consolidated financial statementsin conformity with generally accepted accounting principles in the UnitedStates of America requires management to make certain estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported results of operations during the reporting periods.Actual results could differ from those estimates.

 

7

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Table of Contents

 

**ANSWERS CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 2 -Summary of Significant Accounting Policies****(cont’d)**

 

**Revenue Recognition**

 

The Company, through its websitesAnswers.com and WikiAnswers.com, generates revenues via advertising in the formof sponsored links and image ads. This includes both pay-per-performance adsand paid-for-impression advertising. In the pay-per-performance model, theCompany earns revenue based on the number of clicks associated with such ads.In the paid-for-impression model, the Company’s revenue is derived from thedisplay of ads.

 

The majority of the Company’sadvertising revenue has been obtained through the efforts of third parties andhas not been the result of direct contracts with advertisers. The third partyis obligated to pay the Company a portion of the revenue it receives fromadvertisers, as compensation for the Company’s sale of promotional space on itsInternet properties. Amounts received from such third parties are reflected asrevenue in the period in which such advertising services are provided.

 

The Company also earnsrevenues from partners that pay the Company for providing them withanswer-based services that they then use in their own products, via co-brandedweb pages.

 

In 2003, the Company sold lifetimesubscriptions to its GuruNet product, which had no defined termination date.Cash received from such lifetime subscriptions was recorded as deferredrevenues and amounted to $425,000. In February 2007, in accordance withthe Company’s rights under the agreements it previously entered into with suchlifetime subscribers, the Company terminated its GuruNet service and therebyextinguished its service obligation to such subscribers. Thus, the Companyrecognized the $425,000 previously deferred, as revenue in the first quarter of2007.

 

TheCompany earned advertising revenue from its two web properties, as follows:

 
| ** **              | ** ** | **Three months ended  September 30** | ** ** | **Nine months ended  September 30** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **              | ** ** | **$ (in thousands)**                      | ** ** |
|                    |       |                                                |       |                                               |       |   |   |   |   |
| **Advertising revenue** |       |                                                |       |                                               |       |   |   |   |   |
|                    |       |                                                |       |                                               |       |   |   |   |   |
| Answers.com             | ** ** | **1,579**                                           |       | 1,861                                              | ** ** | **4,891** |   | 7,179 |   |
| WikiAnswers             | ** ** | **1,960**                                           |       | 304                                                | ** ** | **4,645** |   | 598 |   |
| ** **              |       | **3,539**                                           |       | 2,165                                              | ** ** | **9,536** |   | 7,777 | ** ** |

 

**Accounting forStock-Based Compensation**

 

Thefair value of stock options granted to employees and directors, is estimated atthe date of grant using the Black-Scholes option-pricing model, which takesinto consideration the share price at the date of grant, the exercise price ofthe option, the expected life of the option, expected interest rates and theexpected volatility.

 

ThroughDecember 31, 2006, due to the lack of adequate history of its own stockvolatility, the Company estimated its own expected stock volatility based onthe historical stock volatility of three other comparable publicly heldcompanies. During 2007, as the Company accumulated its own volatility historyover longer periods of time, the Company’s assumptions about its stock pricevolatility were based on a rate that has been derived by taking intoconsideration the volatility rates of the aforesaid comparable publicly heldcompanies as well as its own historical volatility rates. Beginning in 2008,the Company estimates its expected stock volatility based solely on its ownhistorical stock volatility rates.

 

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**ANSWERS CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 2 -Summary of Significant Accounting Policies****(cont’d)**

 

**Net Loss perCommon Share**

 

Basic and diluted net loss per common share is computedby dividing the net loss attributable to common stockholders by the weightedaverage number of common shares outstanding for the period. Diluted net loss per share is the same asbasic net loss per share as the inclusion of the Company’s outstanding commonstock equivalents would be anti-dilutive.

 

Thetable below presents the computation of basic and diluted net loss per commonshare:

 
| ** **                                                                                     | ** ** | **Three months ended  September 30**                                           | ** ** | **Nine months ended  September 30** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2008**                                                                                      | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                     | ** ** | **$ (in thousands, except share and per share data)** | ** ** |
|                                                                                           |       |                                                                                          |       |                                               |       |   |   |   |   |
| **Net loss**                                                                                   | ** ** | **(2,119**                                                                                    | **)**      | (1,950                                             | )          | **(10,405** | **)** | (3,501 | ) |
|                                                                                           |       |                                                                                          |       |                                               |       |   |   |   |   |
| Series A Convertible Preferred Stock  dividends                                           |       | (91                                                                                           | )          | —                                             |       | (106 | ) | — |   |
| Amortization of Series A Convertible  Preferred Stock discounts                           |       | (239                                                                                          | )          | —                                             |       | (279 | ) | — |   |
|                                                                                           |       |                                                                                          |       |                                               |       |   |   |   |   |
| **Net loss attributable to common shares**                                                     | ** ** | **(2,449**                                                                                    | )          | (1,950                                             | **)**      | **(10,790** | ) | (3,501 | ) |
|                                                                                           |       |                                                                                          |       |                                               |       |   |   |   |   |
| **Weighted average shares used  in computing****basic  and diluted net loss per common share** | ** ** | **7,865,263**                                                                                 |       | 7,854,053                                          | ** ** | **7,861,681** |   | 7,844,900 |   |
|                                                                                           |       |                                                                                          |       |                                               |       |   |   |   |   |
| **Basic and diluted net loss  per common share**                                               | ** ** | **(0.31**                                                                                     | **)**      | (0.25                                              | )          | **(1.37** | **)** | (0.45 | ) |

 

**Derivativesand hedging**

 

The Company accounts forderivatives and hedging based on Statement of Financial Accounting Standards133,*“Accounting for Derivative Instrumentsand Hedging Activities”* (SFAS 133). SFAS 133 requires the Company torecognize all derivatives on the balance sheet at fair value. If thederivatives meet the definition of a hedge and are so designated, depending onthe nature of the hedge, changes in the fair value of derivatives will eitherbe offset against the change in fair value of the hedged assets, liabilities,or firm commitments through earnings, or recognized in other comprehensiveincome until the hedged item is recognized in earnings. The ineffective portionof a derivative’s change in fair value is recognized in earnings.

 

During the nine monthsended September 30, 2008 and 2007, the Subsidiary entered into optioncontracts to hedge certain foreign currency denominated expenses. Thesederivatives were not designated as hedging instruments under the rules ofSFAS 133 and, therefore, the net gains (losses) are recognized in earningsas they occur. Such gains (losses) are included in operating expenses asfollows:

 
| ** **                 | ** ** | **Three months ended  September 30** | ** ** | **Nine months ended  September 30** | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                            | ** ** | **2007**                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                 | ** ** | **$ (in thousands)**                      | ** ** |
|                       |       |                                                |       |                                               |       |   |   |   |   |
| Cost of revenue            | ** ** | **(3**                                              | **)**      | **8**                                              | ** ** | **6** | ** ** | **8** | ** ** |
| Research and development   | ** ** | **(26**                                             | **)**      | **23**                                             | ** ** | **22** | ** ** | **23** | ** ** |
| Sales and marketing        | ** ** | **(2**                                              | **)**      | **22**                                             | ** ** | **5** | ** ** | **22** | ** ** |
| General and administrative | ** ** | **(13**                                             | **)**      | **16**                                             | ** ** | **13** | ** ** | **16** | ** ** |
| ** **                 | ** ** | **(44**                                             | **)**      | **69**                                             | ** ** | **46** | ** ** | **69** | ** ** |

 

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**ANSWERSCORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 2 -Summary of Significant Accounting Policies****(cont’d)**

 

**RecentlyIssued Accounting Standards**

 

In March 2008, the FASBissued Statement of Financial Accounting Standards 161, *“Disclosures about Derivative Instruments and HedgingActivities-an amendment of FASB Statement No. 133”* (SFAS 161).SFAS 161 gives financial statement users better information about the reportingentity’s hedges by providing for qualitative disclosures about the objectivesand strategies for using derivatives, quantitative data about the fair value ofand gains and losses on derivative contracts, and details ofcredit-risk-related contingent features in their hedged positions. SFAS 161 iseffective for financial statements issued for fiscal years beginning after November 15,2008 and interim periods within those years. The Company is currently evaluatingthe potential impact of the adoption of SFAS 161 on its consolidated financialposition, results of operations and cash flows.

 

On May 9, 2008, the FASB issued FASB StaffPosition No. APB 14-1(FSP APB 14-1), *“Accountingfor Convertible Debt Instruments That May Be Settled in Cash UponConversion (Including Partial Cash Settlement)”*. FSP APB 14-1requires issuers of convertible debt that may be settled wholly or partly incash when converted to account for the debt and equity components separately.FSP APB 14-1 is effective for fiscal years beginning after December 15,2008 and must be applied retrospectively to all periods presented. The Company is currently evaluating the potential impact of the adoption ofFSP APB14-1 on its consolidated financial statements.

 

**Note 3 – Capital Leases**

 

In April 2008, the Company entered into severalcapital lease agreements to purchase equipment for its new co-location serverfacility (see note 10 (b)). The capitalized leases are included in property andequipment as follows:

 
| ** **                     | ** ** | **As of September 30** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|
| ** **                     | ** ** | **2008**                              | ** ** | **2007** | ** ** |
| ** **                     | ** ** | **$ (in thousands)**        | ** ** |
|                           |       |                                  |       |   |   |
| Computer equipment             | ** ** | **239**                               |       | — |   |
| Less: accumulated depreciation | ** ** | **(38**                               | )          | — |   |
|                           |       |                                  |       |   |   |
| ** **                     |       | **201**                               |       | — |   |

 

**Note 4 –Brainboost Answer Engine**

 

In December 2005, the Company acquired BrainboostTechnology, LLC, developer of the Brainboost Answer Engine (“BAE”), anartificial intelligence technology enabling natural languagequestion-and-answer search on the Web. As consideration for the acquisition,the Company paid $4.0 million in cash and 439,000 shares of its restrictedstock, valued at approximately $5.6 million at the time of the acquisition. Inconnection with the initial allocation of the purchase price, the Companyrecorded an intangible asset, with an estimated useful life of six years, ofapproximately $5.4 million.

 

In the second quarter of 2008, the Company decidedto focus its efforts, in the realm of questions-and-answers, solely onuser-generated, questions-and-answers, and effectively abandoned its use of theBAE. This decision was implemented on May 25, 2008, when changes were madeto Answers.com, virtually eliminating the use of the BAE, which the Companybelieves has no further service potential.

 

As a result of the Company’sdecision to effectively abandon its use of the BAE, the net book value of theBAE as of May 25, 2008, in the amount of $3,138,000, was written off, andthe resulting charge is included in the Company’s operating expenses for thenine months ended September 30, 2008.

 

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**ANSWERS CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 5 – Redpoint Financing**

 

OnJune 16, 2008, pursuant to a private placement of the Company’ssecurities, Redpoint Omega, L.P. and Redpoint Omega Associates, LLC(collectively, “Redpoint”) purchased $6,000,000 of the Company’s Series AConvertible Preferred Stock, initially convertible into 1,333,333 shares ofcommon stock at a conversion price of $4.50 per share, and Common StockPurchase Warrants exercisable for 666,667 shares of common stock at an exerciseprice of $4.95 per share (“Series A Warrants”). Redpoint also received awarrant, exercisable until June 16, 2009, to purchase units of up to $7 millionof Series B Convertible Preferred Stock and Common Stock Purchase Warrantsexercisable for 636,364 shares of common stock (“Series B Warrants”). The Series BConvertible Preferred Stock is initially convertible into 1,272,727 shares ofcommon stock at a conversion price of $5.50 per share. The Series BWarrants have an exercise price of $6.05 per share. After deducting placementagent fees and legal expenses, the Company’s net proceeds from the privateplacement were approximately $5,380,000. The Series A ConvertiblePreferred Stock, the Series B Convertible Preferred Stock, the Series AWarrants and the Series B Warrants are collectively referred to as the “RedpointSecurities”. The warrant to purchase units of Series B ConvertiblePreferred Stock and Series B Warrants is referred to as the “Series BUnit Warrant”.

 

TheSeries A Convertible Preferred Stock has the rights and preferences setforth in the Company’s Certificate of Designations, which amended the Company’sAmended and Restated Certificate of Incorporation as of its date of filing on June 16,2008 (see Note 7). The Series B Convertible Preferred Stock, if purchasedby Redpoint pursuant to its Series B Unit Warrant, will have similarrights and preferences as the Series A Convertible Preferred Stock.

 

In connection with the private placement the Companyentered into a registration rights agreement with Redpoint, pursuant to whichthe Company agreed to register with the SEC for resale the common stock underlyingthe Redpoint Securities. In connection with the registration rights agreement,the Company agreed to pay a penalty of 1.0% per month, on a daily pro ratabasis, up to a maximum of 8.0%, of the aggregate purchase price, as partialliquidated damages, for certain default events and subject to certaincircumstances. The partial liquidated damages may trigger if the registrationstatement, which the Company filed on July 30, 2008, and which wasdeclared effective by the SEC on September 16, 2008, ceases to remaincontinuously effective. The Company also agreed to use its reasonable bestefforts to obtain all required stockholder approval for the authorization andissuance of the common stock underlying the Redpoint Securities by September 15,2008, and such approval was obtained on September 9, 2008.

 

In connection with theprivate placement, Redpoint received the right to appoint an individual toserve as a voting member of the Company’s board of directors. If Redpointexercises the Series B Unit Warrant and meets certain ownershiprequirements, it will be entitled to appoint a second member to the Company’sboard of directors.

 

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**ANSWERSCORPORATION**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 5 – Redpoint Financing (cont’d)**

 

**Accounting**

 

The $6,000,000 of proceeds from the RedpointFinancing were first allocated to the Series B Unit Warrant, which wasclassified as a liability, based on its fair value, and the residual amount wasallocated among the Series A Convertible Preferred Stock and the Series AWarrants based on their relative fair values, all in accordance with theguidance in SFAS 150, *“Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity”*, and EITF 00-19, *“Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock”*. The Series A Convertible Preferred Stockhas been classified as temporary equity, in accordance with the guidance inEITF D-98, *“Classification and Measurementof Redeemable Securities”*, and the Series A Warrants have beenclassified in permanent equity.

 

In recording the effects of the transaction, theCompany allocated the consideration from the purchase of the RedpointSecurities as follows:

 
| ** **              | ** ** | **Series A  Convertible  Preferred Stock** | ** ** | **Series A  Warrants** | ** ** | **Series B  Unit  Warrant** | ** ** | **Total** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|-----------------------------|------------|----------------------------------|------------|-----------|------------|
| ** **              | ** ** | **$ (in thousands)**                       | ** ** |
|                    |       |                                                 |       |                        |       |                             |       |      |       |
| Allocated amount        |       | 1,972                                                |       | 517                         |       | 3,511                            |       | 6,000     |       |
| Less: Transaction costs |       | (204                                                 | )          | (53                         | )          | (363                             | )          | (620      | )          |
|                    |       |                                                 |       |                        |       |                             |       |      |       |
|                    |       | 1,768                                                |       | 464                         |       | 3,148                            |       | 5,380     |       |

 

Transaction costs were allocated on a pro ratedbasis, based on the amounts allocated to each of the components of thetransaction. Transaction costs relating to the Series A ConvertiblePreferred Stock and Series A Warrants have been reflected as a reductionto the proceeds from the issuance of such instruments. Transaction costsrelating to the Series B Unit Warrant have been deferred and are beingamortized to interest expense over one year, which is the life of the warrant.

 

**Series A Convertible PreferredStock**

 

In accordance with guidance in EITF D-98, *“Classification and Measurement of RedeemableSecurities”*and other accounting literature, the Series AConvertible Preferred Stock has been recorded at its initial relative fairvalue and classified in temporary equity. Subsequent changes to its fair valuewill not be recognized as long as the stock continues to be classified astemporary equity and not as a liability.

 

**Series A Warrants**

 

The relative fair value ofthe Series A Warrants, as explained above, has been recorded andclassified as additional paid in capital in permanent equity, as describedabove, with a corresponding discount to the Series A Convertible PreferredStock. Such discount is amortized to paid-in capital through the earliestredemption date of the stock, which is six years after the date of issuance. Asof September 30, 2008, approximately $22,000 of such discount has beenamortized.

 

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**ANSWERSCORPORATION**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 5 – Redpoint Financing (cont’d)**

 

**Series B Unit Warrant**

 

The Series B Unit Warrant has been recorded asa liability, with a corresponding discount to the Series A ConvertiblePreferred Stock. Such discount is amortized against paid-in capital through theearliest redemption date of the stock, which is six years after the date ofissuance. As of September 30, 2008, approximately $171,000 of suchdiscount has been amortized.

 

The Series B UnitWarrant is revalued each reporting date. The Company assessed the value of the Series BUnit Warrant as of September 30, 2008, as compared to its value, asreported, as of June 30, 2008. The change in the amount of $2,056,000 hasbeen included in the statement of operations as loss resulting from fair valueadjustment of warrant to purchase units of Series B preferred stock andwarrants for the three and nine months ended September 30, 2008.

 

**Beneficial Conversion Feature**

 

The effective conversion rate of the Series AConvertible Preferred Stock, after allocation of the proceeds as describedabove, as compared to the fair market value of the Company’s common stock onthe date of issuance, represents an additional beneficial conversion value.Thus, the Company recorded an additional discount to the Series AConvertible Preferred Stock, with a corresponding increase in paid-in capital,of $1,768,000, reducing the Series A Convertible Preferred Stock to zero.In accordance with EITF 00-27, *“Applicationof Issue No. 98-5 to Certain Convertible Instruments”*, theaforesaid discount is amortized to paid-in capital over six years from the dateof issuance, the earliest redemption date of the stock. As of September 30,2008, approximately $86,000 of such discount has been amortized.

 

There are additional features of the Series AConvertible Preferred Stock which represent contingent beneficial conversionfeatures, to be reevaluated in the future. In the event that the facts andcircumstances indicate that a contingency is removed, at that point thebeneficial conversion feature, if any, will be recorded.

 

**Dividends**

 

TheSeries A Convertible Preferred Stock accrues cumulative dividends at arate of 6% per annum whether or not dividends have been declared by the Company’sBoard of Directors and whether or not there are profits, surplus or other fundsavailable for the payment of such dividends.  Due to the Company’sdecision to pay such dividends in the form of shares of common stock, thedividend accrual is reflected as an increase in the stated value of the Series AConvertible Preferred Stock with a corresponding decrease in the additionalpaid-in capital.

 

**Note 6 – Fair ValueMeasurements**

 

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards 157,*“Fair Value Measurements”,*(SFAS 157), except as it applies to the nonfinancialassets and nonfinancial liabilities subject to FASB Staff Position No. 157-2. SFAS 157 clarifies that fair value isan exit price, representing the amount that would be received to sell an assetor paid to transfer a liability in an orderly transaction between marketparticipants. As such, fair value is a market-based measurement that should bedetermined based on assumptions that market participants would use in pricingan asset or a liability. As a basis for considering such assumptions, SFAS 157establishes a three-tier value hierarchy, which prioritizes the inputs used inthe valuation methodologies in measuring fair value:

 

**Level 1** - Observable inputs that reflect quotedprices (unadjusted) for identical assets or liabilities in active markets.

**Level 2** - Include other inputs that are directly orindirectly observable in the marketplace.

**Level 3** - Unobservable inputs which are supported bylittle or no market activity.

 

The fair value hierarchy also requires an entity tomaximize the use of observable inputs and minimize the use of unobservableinputs when measuring fair value.

 

The Company measures its cash equivalents, foreigncurrency derivative contracts, deposits in respect of employee severance payand Warrant to purchase units of Series B preferred stock and warrant, atfair value. In accordance with SFAS 157, the Company’s cash equivalents,foreign currency derivative contracts and deposits in respect of employeeseverance pay are classified within Level 1 or Level 2. This is because thecash equivalents, foreign currency derivative contracts and deposits in respectof employee severance pay are valued using quoted market prices or alternativepricing sources and models utilizing market observable inputs. The Warrant topurchase units of Series B preferred stock and warrants is classifiedwithin Level 3 because it is valued using a combination of Monte-Carlosimulation and Black-Scholes model. Some of the inputs to this valuation areunobservable in the market and are significant.

 

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**ANSWERSCORPORATION**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 6 – Fair ValueMeasurements****(cont’d)**

 

Assets and liabilities measured at fair value aresummarized below:

 
| ** **                                                               | ** ** | **Fair value measurement at reporting date using** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| **Description**                                                          | ** ** | **September 30,  2008**                                                          | ** ** | **Quoted Prices in Active  Markets for Identical  Assets  (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** | **Significant  Unobservable Inputs  (Level 3)** | ** ** |
| ** **                                                               | ** ** | **$ (in thousands)**                                                   | ** ** |
| **Assets**                                                               |       |                                                                             |       |   |   |   |   |   |   |
| Cash Equivalents                                                         |       |                                                                             |       |   |   |   |   |   |   |
| Money Market Funds                                                       |       | 8,264                                                                            |       | 8,264 |   | — |   | — |   |
| Foreign currency derivative contracts                                    |       | 11                                                                               |       | — |   | 11 |   | — |   |
| Deposits in respect of employee severance  pay                           |       | 1,430                                                                            |       | 1,430 |   | — |   | — |   |
| **Total Assets**                                                         |       | 9,705                                                                            |       | 9,694 |   | 11 |   | — |   |
|                                                                     |       |                                                                             |       |   |   |   |   |   |   |
| **Liabilities**                                                          |       |                                                                             |       |   |   |   |   |   |   |
| Warrant to purchase units of Series B  preferred stock and warrants |       | 5,567                                                                            |       | — |   | — |   | 5,567 |   |

 

The following table presents the Company’s assetsmeasured at fair value using significant unobservable inputs (Level 3) asdefined in SFAS 157, as of September 30, 2008:

 
| ** **                                                                                                                      | ** ** | **Level 3**               | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                      | ** ** | **$ (in thousands)** | ** ** |
|                                                                                                                            |       |                           |       |
| **Balance at December 31, 2007**                                                                                           | ** ** | **—**                     | ** ** |
|                                                                                                                            |       |                           |       |
| Initial valuation of warrant to purchase units of Series B  preferred stock and warrants                                   |       | 3,511                          |       |
| Loss resulting from fair value,  included in statement of operations for the three andnine months ended September 30, 2008 |       | 2,056                          |       |
| ** **                                                                                                                      | ** ** | ** **                     | ** ** |
| **Balance at September 30, 2008**                                                                                          | ** ** | **5,567**                      | ** ** |

 

 

**Note 7 - Series AConvertible Preferred Stock**

 

The following table summarizes thechanges in the Series A Convertible Preferred Stock resulting fromissuance through September 30, 2008:

 
| ** **                                                               | ** ** | **$ (in thousands)** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------|------------|
|                                                                     |       |                           |       |
| **Gross proceeds**                                                       | ** ** | **6,000**                      | ** ** |
|                                                                     |       |                           |       |
| Issuance costs                                                           |       | (204                           | )          |
| Discount resulting from the  issuance of the Series A Warrants      |       | (517                           | )          |
| Discount resulting from the  issuance of the Series B Unit Warrant  |       | (3,511                         | )          |
| Discount resulting from the  Beneficial Conversion Feature               |       | (1,768                         | )          |
| Amortizations of discounts from  closing through September 30, 2008 |       | 279                            |       |
| Accrued dividends                                                        |       | 106                            |       |
| ** **                                                               | ** ** | ** **                     | ** ** |
| ** **                                                               | ** ** | **385**                        | ** ** |

 

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**ANSWERSCORPORATION**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 7 - Series AConvertible Preferred Stock****(cont’d)**

 

As a result of the Redpoint Financing (see note 5),the Company’s Amended and Restated Certificate of Incorporation has beenamended to provide for the issuance of up to 60,000 shares of Series AConvertible Preferred Stock with a stated value of $100 per share (the “StatedValue”) pursuant to the Certificate of Designations, Number, Voting Powers, Preferencesand Rights of Series A Convertible Preferred Stock filed with the State ofDelaware on June 16, 2008 (the “Certificate of Designations”).

 

The Certificate of Designations provides for thefollowing rights and preferences:

 

**Dividends**

 

TheSeries A Convertible Preferred Stock will accrue cumulative dividends at arate of 6% per annum whether or not dividends have been declared by the Boardof Directors and whether or not there are profits, surplus or other fundsavailable for the payment of such dividends.  Dividends may be payable inkind at the option of the Company upon satisfaction of certain conditions.

 

**Voting Rights**

 

TheSeries A Convertible Preferred Stock shall vote on an as converted basiswith the Company’s common stock.  So long as any shares of Series AConvertible Preferred Stock are outstanding, the Company shall not, without theaffirmative vote of the holders of a majority of the shares of the Series AConvertible Preferred Stock then outstanding (each holder of Series AConvertible Preferred Stock, a “ Holder “ and collectively, the “ Holders) , (a) alteror change adversely the powers, preferences or rights given to the Series AConvertible Preferred Stock or alter or amend the Certificate of Designations(whether by merger, consolidation or otherwise), (b) authorize or createany class of stock ranking as to dividends, redemption or distribution ofassets upon a Liquidation senior to or otherwise pari passu with the Series AConvertible Preferred Stock, except for any series of Preferred Stock issued tothe Holders, (c) amend its certificate of incorporation or other charterdocuments (whether by merger, consolidation or otherwise) so as to affectadversely any rights of the Holders, (d) increase or decrease theauthorized number of shares of Series A Convertible Preferred Stock, or (e) enterinto any agreement with respect to the foregoing.

 

**Liquidation**

 

Uponan event of liquidation, as defined in the Certificate of Designations (a “Liquidation”),the Holders shall be entitled to receive out of the assets of the Company,whether such assets are capital or surplus, for each share of Series AConvertible Preferred Stock an amount equal to greater of (i) the StatedValue per share plus any accrued and unpaid dividends thereon and any otherfees or liquidated damages owing thereon before any distribution or paymentshall be made to the holders of any junior securities or (ii) such amountper share as would have been payable had all shares of Series AConvertible Preferred Stock been upon any such Liquidation converted to commonstock immediately prior to such Liquidation, in any case, and if the assets ofthe Company shall be insufficient to pay in full such amounts, then the entireassets to be distributed to the Holders shall be distributed among the Holdersratably in accordance with the respective amounts that would be payable on suchshares if all amounts payable thereon were paid in full.

 

**Conversions at Option of Holder**

 

Each share of Series A Convertible PreferredStock shall be convertible into that number of shares of common stock (“CommonStock”) determined by dividing the Stated Value plus any accrued but unpaiddividends thereon (to the extent not already included in the Stated Value) ofsuch share of Series A Convertible Preferred Stock by $4.50 (the “ConversionPrice”), at the option of the Holder, at any time and from time to time.

 

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**ANSWERSCORPORATION**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 7 - Series AConvertible Preferred Stock****(cont’d)**

 

**Mandatory Conversion**

 

BeginningDecember 16, 2009, provided certain conditions are satisfied, if theclosing price of the Common Stock equals an average of $13.50 (subject toadjustment for stock splits, reclassifications, combinations and similaradjustments) per share for the 45 consecutive trading days immediately prior tothe Automatic Conversion Notice Date (as defined below), and average dailyvolume of the Common Stock on The Nasdaq Capital Market averages at least$1,000,000 during such measurement period, unless the Holder is prohibited fromconverting the Series A Convertible Preferred Stock pursuant to certainlimitations set forth in the Certificate of Designations, the Company shallhave the right to deliver a notice to the Holder (an Automatic ConversionNotice, and the date such notice is received by the Holder, the AutomaticConversion Notice Date), to convert any portion of the shares of Series AConvertible Preferred Stock then held by the holder into shares of Common Stockat the then-effective Conversion Price.

 

**Redemption**

 

Atanytime on or after June 16, 2014, upon written request by the majority ofthe Holders, the Company shall redeem all or any portion of the thenoutstanding Series A Convertible Preferred Stock, for an amount in cashequal to the sum of (i) 100% of the aggregate Stated Value thenoutstanding and (ii) accrued but unpaid dividends (to the extent notalready included in Stated Value) and (iii) all liquidated damages andother amounts due in respect of the Series A Convertible Preferred Stock.

 

**Subsequent Equity Sales**

 

Ifthe Company, at any time while Series A Convertible Preferred Stock isoutstanding, shall sell or grant any option to purchase or otherwise dispose ofor issue any Common Stock or Common Stock equivalents entitling any person toacquire shares of Common Stock, at an effective price per share less than thethen effective Conversion Price, then, the Conversion Price shall be adjustedon a broad weighted average basis.

 

**Participation Rights**

 

Atany time while Series A Convertible Preferred Stock is outstanding (or theCommon Stock issuable or issued upon conversion thereof) and the Holders ortheir affiliates collectively hold a majority of the outstanding Series AConvertible Preferred Stock (or the Common Stock issuable or issued uponconversion thereof) purchased by the Holders, each Holder shall have a right toparticipate pro rata with respect to the issuance or possible issuance by theCompany of any future equity or equity-linked securities or debt which isconvertible into or exercisable or exchangeable for equity or in which there isan equity component on the same terms and conditions as offered by the Companyto the other purchasers of such securities.

 

**Note 8 – Stockholders’ Equity**

 

**General**

 

The following table summarizes thechanges in the Company’s stockholders’ equity during the nine-month periodending September 30, 2008:

 
| ** **                                                               | ** ** | **$ (in thousands)** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------|------------|
|                                                                     |       |                           |       |
| **December 31, 2007**                                               | ** ** | **14,771**                     | ** ** |
|                                                                     |       |                           |       |
| Stock-based compensation                                                 |       | 1,312                          |       |
| Discount resulting from the  issuance of the Series A Warrants      |       | 464                            |       |
| Discount resulting from the  Beneficial Conversion Feature               |       | 1,768                          |       |
| Amortizations of discounts from  closing through September 30, 2008 |       | (279                           | )          |
| Accrued dividends                                                        |       | (106                           | )          |
| Stock registration costs                                                 |       | (47                            | )          |
| Exercise of stock options                                                |       | 10                             |       |
| Net loss for the period                                                  |       | (10,405                        | )          |
| ** **                                                               | ** ** | ** **                     | ** ** |
| **September 30, 2008**                                              | ** ** | **7,488**                      | ** ** |

 

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** **

**ANSWERS CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 8 – Stockholders’ Equity (cont’d)**

 

**CommonStock**

 

At the stockholders’annual meeting which was held on September 9, 2008, the stockholders ofthe Company agreed to amend the Company’s Amended and Restated Certificate ofIncorporation to increase the authorized common stock to 100,000,000 sharesfrom 30,000,000 shares;

 

**StockWarrants**

 

As of September 30,2008, there were 1,824,430 outstanding stock warrants with a weighted averageexercise price of $12.09. All warrants are exercisable immediately. No warrantswere exercised during the nine months ended September 30, 2008.

 

**Stock Options**

 

During the nine months endedSeptember 30, 2008, the Company granted a total of 410,150 stock optionsto its employees and officers at an average exercise price of $4.17 per option.Additionally, during the same period, 10,648 stock options were exercised and 198,324 stock options were forfeited.

 

The total fair value of stock options vested during thenine months ended September 30, 2008, amounted to $1,312 thousand and wasrecorded as stock-based compensation expense.

 

At the stockholders’ annualmeeting which was held on September 9, 2008, the stockholders of theCompany agreed to amend the Company’s 2005 Incentive Compensation Plan toincrease the number of shares available for grant under such plan from1,100,000 shares to 1,350,000 shares. As of September 30,2008, 240,515 and 17,850 options were available for grant under the 2005 Planand the 2004 Stock Plan, respectively. All Prior Option Plans are closed forfuture grants.

 

**Note 9 – Income Taxes**

 

**FIN 48**

 

As of September 30,2008 and December 31, 2007, the Company’s unrecognized tax benefits,including associated estimated interest and penalties which were not material,were $70 thousand and $263 thousand, respectively.  Of the total unrecognized tax benefits at September 30,2008 and December 31, 2007, approximately $68 thousand and $114 thousand,if recognized, would impact the effective tax rate in those respective periods.

 

In September 2008, theIsraeli income tax authorities completed its audit of the Subsidiary for thetax years 2004 through 2006, resulting in no adjustments, pending finalapproval. As a result of the findings of such audit, the Company reversedpreviously accrued tax provisions.

 

**Note 10 - Commitments and Contingencies**

 

(a)          Future minimum lease payments under non-cancelableoperating leases for office space and cars, as of September 30, 2008, areas follows:

 
| **Year ending December 31**         | ** ** | **$ (in thousands)** | ** ** |
|----------------------------------------------------|------------|--------------------------------|------------|
|                                               |       |                           |       |
| 2008 (three months ending  December 31, 2008) |       | 142                            |       |
| 2009                                               |       | 507                            |       |
| 2010                                               |       | 309                            |       |
| 2011                                               |       | 11                             |       |
| ** **                                         | ** ** | ** **                     | ** ** |
|                                               | ** ** | 969                            | ** ** |

 

Rental expense for operating leases for the three monthsended September 30, 2008 and 2007 was approximately $158,000, and$126,000, respectively. Rental expense for operating leases for the nine monthsended September 30, 2008 and 2007 was approximately $456,000, and$370,000, respectively.

 

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**ANSWERS CORPORATION****NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 10 – Commitments and Contingencies (cont’d)**

 

(b)         Future minimum lease payments undernon-cancelable capital leases for computer equipment, as of September 30,2008, are as follows:

 
| **Year ending December 31**         | ** ** | **Principal**                  | ** ** | **Interest** | ** ** |
|----------------------------------------------------|------------|--------------------------------|------------|--------------|------------|
| ** **                                         | ** ** | **$ (in thousands)** | ** ** |
|                                               |       |                           |       |         |       |
| 2008 (three months ending  December 31, 2008) |       | 19                             |       | 2            |       |
| 2009                                               |       | 78                             |       | 8            |       |
| 2010                                               |       | 82                             |       | 3            |       |
| 2011                                               |       | 24                             |       | 1            |       |
| ** **                                         | ** ** | ** **                     | ** ** | ** **   | ** ** |
|                                               |       | 203                            |       | 14           | ** ** |

 

(c)          A bank guarantee given to theSubsidiary’s landlord, is secured by a restricted long-term deposit of $139,000and collateralized by some of the Subsidiary’s bank deposits (as of September 30,2008, such deposits amounted to $361,000).

 

(d)         In the ordinary course of business,the Company enters into various arrangements with vendors and other businesspartners, principally for content, web-hosting, marketing and variousconsulting arrangements. As of September 30, 2008, the total futurecommitments under these arrangements amount to approximately $711,000.

 

(e)          In the ordinary course of business,the Company may provide indemnifications of varying scope and terms tocustomers, vendors, lessors, business partners, and other parties with respectto certain matters, including, but not limited to, losses arising out of itsbreach of agreements, services to be provided by it, or from intellectualproperty infringement claims made by third parties. Additionally, the Company,through its operating agreement, has indemnified its members, officers,employees, and agents serving at the request of the Company to the fullestextent permitted by applicable law. It is not possible to determine the maximumpotential amount of liability under these indemnification agreements due to thelimited history of prior indemnification claims and the unique facts andcircumstances involved in each particular agreement. Such indemnificationagreements may not be subject to maximum loss clauses. To date, the Company hasnot incurred costs as a result of obligations under these agreements and hasnot accrued any liabilities related to such indemnification obligations in itsaccompanying financial statements.

 

(f)            Fromtime to time, the Company receives various legal claims incidental to itsnormal business activities, such as intellectual property infringement claimsand claims of defamation and invasion of privacy. Although the results ofclaims cannot be predicted with certainty, the Company believes the finaloutcome of such matters will not have a material adverse effect on itsfinancial position, results of operations, or cash flows.

 

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**ANSWERS CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 10 - Commitments and Contingencies (cont’d)**

 

(g)         On July 13, 2007, the Companyentered into a Purchase Agreement to acquire all of the outstanding limitedliability interests of Lexico Publishing Group, LLC for an aggregate purchaseprice of $100 million in cash, subject to adjustments for closing net workingcapital. Consummation of the acquisition of Lexico was subject to the Company’sability to secure financing for the acquisition.

 

On July 17, 2007, the Company filed a universalshelf registration statement on Form S-3 with the Securities and ExchangeCommission which was declared effective on August 6, 2007. Theregistration statement covers up to an aggregate of $140,000,000 of commonstock, preferred stock, warrants, debt securities, units or any combinationthereof. The Company filed various prospectus supplements for a proposed publicoffering, the latest of which was filed on February 8, 2008. On February 13,2008 the Company canceled its proposed public offering due to unfavorablemarket conditions.

 

On March 1, 2008, the members of Lexico terminatedthe purchase agreement, due to the Company’s inability to finance theacquisition. As a result of the termination of the purchase agreement, theCompany reimbursed $500,000 of the sellers’ transaction-related legal and accountingexpenses, as provided for in the Purchase Agreement.

 

Additionally, in connection with the Lexico transaction,on January 15, 2008, the Company entered into a Securities PurchaseAgreement with an institutional investor, or the senior notes investor, for theoptional purchase and sale of $8.5 million aggregate principal amount of itssenior secured convertible notes due 2010, or the senior secured convertiblenotes. The Company’s intent was to close the senior secured convertible notesfinancing in conjunction with its follow-on offering, if it needed such fundsto close the Lexico acquisition. Since the Company’s purchase agreement withLexico was terminated, the Securities Purchase Agreement was also terminatedand the Company paid the senior secured convertible notes investor atermination fee of $425 thousand, as provided for in the Securities PurchaseAgreement.

 

In addition to the payments to Lexico and the seniornotes investor, aggregating $925,000, the Company incurred approximately $1,270,000and $348,000 of costs, including legal, accounting, banking, consulting andtravel costs, in 2007 and in the first quarter of 2008, respectively, inconnection with the proposed acquisition of Lexico and follow-on offering. Thepayments to Lexico, to the senior notes investor, and the additional costs,collectively $2,543,000, are included in the operating expenses on the Company’sstatement of operations for the nine months ended September 30, 2008.

 

**Note 11 – Risks and Uncertainties**

 

Practicallyall of the Company’s advertising revenue was generated through the efforts ofthird party suppliers (the “Monetization Partners”). During the three monthsending September 30, 2008, the Company earned approximately 82% of itsadvertising revenue through one of its Monetization Partners, Google Inc.,compared to 69% of advertising revenue from Google during the third quarter of2007. During the nine months ending September 30, 2008, the Company earnedapproximately 79% of its advertising revenue through Google, compared to 71% ofadvertising revenue during the same period in 2007.

 

Searchengines serve as origination Web properties for users in search of information,and the Company’s Websites’ topic pages often appear as one of the toplinks on the pages returned by search engines in response to users’ searchqueries. Thus, in addition to the ads the Company receives through Google, itstraffic is mostly driven by search engine traffic, mostly from the Googlesearch engine. For the three months ended September 30, 2008, according tothe Company’s internal estimates, search engine traffic representedapproximately 77% of traffic. Search engines, at any time and for any reason,could change their algorithms that direct queries to the Company’s Webproperties or could restrict the flow of users visiting the Company’s Webproperties specifically. In fact, on occasion the Company’s Web properties haveexperienced decreases in traffic, and consequently in revenue, due to thesesearch engine actions. The Company cannot guarantee that it will successfullyreact to these actions in the future and recover lost traffic. Accordingly, achange in algorithms that search engines use to identify Web pages towardswhich traffic will ultimately be directed, or a restriction on the flow ofusers visiting the Company’s Web properties from search engines, could cause asignificant decrease in traffic and revenues.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion andanalysis should be read in conjunction with, and is qualified in its entiretyby, our financial statements (and notes related thereto) and other moredetailed financial information appearing elsewhere in this report. Consequently*, y*oushould read the following discussion and analysis of our financial conditionand results of operations together with such financial statements and otherfinancial data included elsewhere in this report. Some of the informationcontained in this discussion and analysis or set forth elsewhere in thisreport, including information with respect to our plans and strategy for ourbusiness, includes forward-looking statements that involve risks anduncertainties. You should review the “Risk Factors” section of this report fora discussion of important factors that could cause actual results to differmaterially from the results described in or implied by the forward-lookingstatements contained in the following discussion and analysis. See also “RiskFactors” in Part II, Item 1A, of this report.*

 

**Overview**

 

We own and operate twoleading Web properties dedicated to providing useful answers in thousands ofcategories. Our award-winning reference site, Answers.com®, includes content on5 million topics from over 180 licensed sources. WikiAnswers.comTM is acommunity-generated social knowledge Q&A platform, leveraging wiki-basedtechnologies. Through the contributions of WikiAnswers’ user-community anddedicated supervisors, answers to the site’s growing database of questions areimproved and updated over time. According to comScore, our Web properties hadapproximately 22.2 million unique visitors in September 2008, which ranksAnswers Corporation number 40 in the top U.S. Web properties. Our goal isto become the leading online provider of answers about anything and the bestplace for people to share knowledge.

 

**RecentEvents**

 

On September 29, 2008, the listing of ourcommon stock was transferred from The NASDAQ Global Market to The NASDAQCapital Market. Our trading symbol was not impacted and remains “ANSW”.

 

**RedpointFinancing**

 

On June 16, 2008,pursuant to a private placement of our securities, Redpoint Omega, L.P. andRedpoint Omega Associates, LLC (collectively, “Redpoint”) purchased $6,000,000of our Series A Convertible Preferred Stock, initially convertible into1,333,333 shares of common stock at a conversion price of $4.50 per share,along with Common Stock Purchase Warrants exercisable for 666,667 shares ofcommon stock at an exercise price of $4.95 per share (Series A PurchaseWarrants”). In conjunction therewith, Redpoint also received a warrant,exercisable until June 16, 2009, to purchase units of up to $7 million of Series BConvertible Preferred Stock and Common Stock Purchase Warrants exercisable for636,364 shares of common stock (“Series B Purchase Warrants”). Thewarrant to purchase units of Series B Convertible Preferred Stock and Series BPurchase Warrants is referred to as the “Series B Unit Warrant”. The Series BConvertible Preferred Stock is initially convertible into 1,272,727 shares ofcommon stock at a conversion price of $5.50 per share. The Series BPurchase Warrants have an exercise price of $6.05 per share.  Afterdeducting placement agent fees and legal expenses, our net proceeds from theprivate placement were $5,380 thousand. The aforesaid transaction iscollectively referred to as the “Redpoint Financing”. The Series AConvertible Preferred Stock, the Series B Convertible Preferred Stock, theSeries A Warrants and the Series B Warrants are collectively referredto as the “Redpoint Securities”.

 

The Series AConvertible Preferred Stock has the rights and preferences set forth in ourCertificate of Designations, Number, Voting Powers, Preferences and Rights of Series AConvertible Preferred Stock, which amended our Amended and Restated Certificateof Incorporation as of its date of filing on June 16, 2008. The Series BConvertible Preferred Stock, if purchased by Redpoint pursuant to the Series BUnit Warrant, will have similar rights and preferences as the Series AConvertible Preferred Stock. For a detailed description of the rights andpreferences of the Series A Convertible Preferred Stock, we refer you tonote 6 to the financial statements included in this quarterly report.

 

In connection with the Redpoint Financing, Redpointreceived the right to appoint an individual to serve as a voting member of ourboard of directors. If Redpoint exercises the Series B Unit Warrantand meets certain ownership requirements, it will be entitled to appoint asecond member to our board.

 

Inconnection with the private placement, we entered into a registration rightsagreement with Redpoint, pursuant to which we agreed to register with the SECfor resale the common stock underlying the Redpoint Securities. In connectionwith the registration rights agreement, we agreed to pay a penalty of 1.0% permonth, on a daily pro rata basis, up to a maximum of 8.0%, of the aggregatepurchase price, as partial liquidated damages, for certain default events andsubject to certain circumstances. The partial liquidated damages will triggerif the registration statement filed with the SEC on July 30, 2008 anddeclared effective on September 16, 2008 ceases to remain continuouslyeffective. We also agreed to use our reasonable best efforts to obtain allrequired stockholder approval for the authorization and issuance of the commonstock underlying the Redpoint Securities by September 15, 2008. On July 30,2008, we filed the registration statement with the SEC, registering the commonstock underlying the Redpoint Securities, and it was declared effective by theSEC on September 16, 2008 and approved by the Company’s stockholders atour annual meeting of stockholders held on September 9, 2008.

 

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**Revenue**

 

***Traffic***

 

Our revenue is primarilydriven by the traffic generated by our Web properties and our ability toeffectively monetize that traffic. Our current sources of traffic include thefollowing:

 

·             Search engines:  Users submitqueries and algorithm search engines respond by generating a list of Web pages thatthey deem likely to offer the most relevant content. When our pages rankhigh in the algorithmic systems of search engines, our results are more likelyto be accessed by users. For the third quarter of 2008, according to ourinternal estimates, this source of traffic represented approximately 77% of ourtraffic.

 

·             Direct users:  Users visiting andreturning to our home pages, and to a far lesser extent, arriving from Webproperties that send us traffic, or via 1-Click Answers and AnswerTips. For thethird quarter of 2008, according to our internal estimates, direct usersrepresented approximately 17% of our traffic.

 

·             Google’s definition link:  We havean informal, non-contractual relationship with Google under which Google linkscertain search results related to definitional queries to Answers.com. For thethird quarter of 2008, according to our internal estimates, this source oftraffic represented approximately 6% of our traffic.

 

Since most of our trafficoriginates from search engines, we expend considerable resources improving thevolume and optimizing the monetization of this traffic. The industry commonlyrefers to such efforts as search engine optimization, or SEO. Our Webproperties have at times experienced decreases in traffic, and consequentlydecreases in revenue, due to search engine actions, including actions byGoogle. In July 2007, a search engine algorithm adjustment by Google ledto a drop in Google directed traffic to Answers.com. This adjustment reducedour overall traffic by approximately 28% based on the average traffic directedto Answers.com from Google for the week prior to the adjustment as compared tothe week after. As a result, our revenue also declined proportionately.

 

We continuously seek toimprove the user experience of visitors to our Web properties, which we believeleads to increased pages per visit, or stickiness, and return visits, oruser-retention. We seek to increase stickiness and user-retention by adding newfeatures, enhancing user interfaces and adding new content to our Webproperties.

 

***Monetization***

 

*AdvertisingRevenue.*  Weearn practically all of our revenue from advertising. There are two primarycategories of Internet advertising: pay-per-performance, or most commonly costper click, or CPC, and pay-per-impression, or cost per 1,000 impressions, orCPM. In the pay-for-performance model we earn revenue based on the number ofclicks associated with an ad; in the paid-for-impression model we deriverevenue from the display of ads. We work with third party ad networks that webelieve optimize the average amount of revenue we earn per page view.Third party ad networks generally compensate us by paying us a portion of therevenue they earn from advertisers for our provision of promotional space onour Web properties.

 

We gauge the effectivenessof our monetization efforts and trends by measuring our revenue per thousand page views,or RPM. Throughout this quarterly report, we refer to estimates of traffic, or page views.In our Management’s Discussion and Analysis of Financial Condition and Resultsof Operations prior to our quarterly report on Form 10-Q for the quarterlyperiod ended June 30, 2008, we tracked the traffic on our Answers.com andWikiAnswers Web properties using two separate systems:

 

(a)          Our Answers.com traffic was measured using our internally developedserver-side, log-based system (“Internal Data Warehouse”). This system wasdesigned to identify traffic from search engine robots and other known Webrobots, commonly referred to as Web spiders or Web crawlers, as well as fromsuspected automated spidering scripts. Traffic from these sources was excludedfrom the traffic activity measurements.

 

(b)         WikiAnswers traffic was tracked using HBX Analytics, a tag-based webanalytics system offered by Omniture, Inc. (formerly offered byWebSideStory). Traffic measurements from this system are generated by ourplacement of tags on our WikiAnswers Web pages. The HBX Analytics system thenindependently generates traffic metrics. WikiAnswers community-relatedstatistics, including total number of questions, answers and users, aregenerated from the WikiAnswers Web property.

 

Beginning with theManagement’s Discussion and Analysis of Financial Condition and Results ofOperations contained in our quarterly report on Form 10-Q for thequarterly period ended June 30, 2008, all traffic measurements (includingmeasurements previously reported in past filings using our Internal DataWarehouse) for Answers.com are also presented based on the HBX Analytics data.We estimate that the historical page views for Answers.com pursuant to HBXAnalytics data, as set forth in our quarterly reports beginning with our  quarterly report on Form 10-Q for thequarterly period ended June 30, 2008, are approximately 11% lower than thetraffic measurements reported in previous filings. Consequently, our Answers.comRPMs, as reported in those quarterly reports, are higher than previous filings.

 

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We also use Google, Inc.’sGoogle Analytics measurement services and Google AdSense data for variousinternal analyses. Our breakdown of our traffic sources, noted above, is basedon such data. Google Analytics measurements are generated by our placement oftags on our Web properties’ pages, which Google Analytics uses to count andreport audience metrics independently.

 

Third party servicesmeasuring traffic audiences may provide different estimates than the estimatesreported by other external services and the estimates reported by internaltracking. These discrepancies may result from differences in methodologiesapplied or the sampling approaches used by each measuring service.

 

Our primary third party adnetwork, Google AdSense, accounted for approximately 82% of our total revenuein the third quarter of 2008 as compared to approximately 69% of our totalrevenue in the third quarter of 2007. Google AdSense accounted forapproximately 79% of our total revenue in the first nine months of 2008 ascompared to approximately 71% of our total revenue in the first nine months of2007. In addition to Google, we utilize the services of other third party adnetworks that provide us with ads. Although there are many companies thatprovide third party ad networks, the loss of Google as a third party ad networkcould have a material adverse impact on our financial condition, as we may notsucceed in receiving terms and ad services as favorable as those provided underour Google Services Agreement (GSA). The GSA was last renewed for an additionaltwo years, through January 31, 2010.

 

*Direct Ad Sales.*  In an effort to improvemonetization, in the fourth quarter of 2006, we began marketing directly toadvertisers and generating additional advertising revenue through an in-houseteam of direct ads salespeople. However, at the end of the second quarter of2008 we decided to suspend this business initiative, and by the end of thethird quarter of 2008 we no longer employ a sales staff. We initially sawpromise in this area, with the belief that our Web properties would see RPMincreases as a result of direct ad sales. In the fourth quarter of 2007, thesales force generated $575 thousand of direct ad revenue. However, direct adrevenue in 2008 was disappointing, with Q1 at $231 thousand and Q2 at $200 thousand. At the end of the second quarterwe came to the belief that the horizontal, educational, reference natureof  made direct ads less compelling forthis Web property. While we viewed WikiAnswers as having the potential tosuccessfully implement a direct ad sales strategy, we decided not to pursuethat strategy and to instead focus on selling ads through advertising networks,primarily Google AdSense. This decision will allow us to focus on our corecompetency — growing the WikiAnswers community, growing traffic to our Webproperties and monetizing via Google and other ad networks.

 

*LicensingRevenue.*  Wealso earn a very minor portion of our revenues from partners that pay us forproviding them with our answer-based services that they then use in their ownproducts, via co-branded Web pages. Revenue from these arrangements are basedon various formulas, including fees based on the number of user queries andfixed periodic fees.

 

**Costs andExpenses**

 

***Cost of Revenue***

 

Cost of revenue consists offees to third party providers of content, Web search service fees, ad servingfees, amortization of the cost of acquired software used in our products, datacenter costs including depreciation of information technology assets,contractual revenue sharing fees to various Web property operators for visitorsdirected to our Web properties, or traffic acquisition costs, as well as thecompensation, travel and overhead costs relating to personnel who areresponsible for content editing and integration, production operations andcustomer support. As revenues increase, we expect our cost of revenue as apercentage of revenue to decrease, since many of its components, such ascontent licensing, are not directly tied to revenue.

 

***Research and Development Expenses***

 

Research and developmentexpenses consist of compensation, travel and overhead costs of personnelconducting research and development of our products and services, andconsulting costs. Our research and development team works primarily on projectsto improve and enhance quality, performance, user interface, productfunctionality, and monetization. We generally expect that our research anddevelopment expenses will decline as a percentage of revenue as we grow ourrevenue.

 

***Sales and Marketing Expenses***

 

Sales and marketing expensesconsist of compensation, travel and overhead costs of personnel in-charge ofWikiAnswers community management, product management and sales and marketing;and public relations, marketing and market information services, and advertisingand promotional costs. We generally expect that our sales and marketingexpenses will decline as a percentage of revenue as we grow our revenue.

 

***General and Administrative Expenses***

 

General and administrativeexpenses consist primarily of compensation, travel and overhead costs forfinancial, legal and administrative personnel, insurance fees, professionalservices, including investor relations, legal, accounting and other consultingfees, amortization of domain names, and other general corporate expenses. Wegenerally expect that our general and administrative expenses will decline as apercentage of revenue as we grow our revenue.

 

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***Overhead costs***

 

Overhead costs consistprimarily of rent, telecommunications, utilities and depreciation expenses.

 

***Stock-Based Compensation***

 

New employees typicallyreceive stock option awards within three months of their start date. We alsogrant additional stock option awards to existing employees and directors,usually once a year. We account for stock-based awards under SFAS No. 123(revised 2004), *“Share-Based Payments”,*orSFAS 123R, which requires measurement of compensation cost for allstock-based awards at fair value on date of grant and recognition ofcompensation over the service period awards are expected to vest. Costsresulting from stock-based compensation are part of our compensation expenseand are included in the operating expense categories in our Statement ofOperations.

 

***Impact of Currency Fluctuations***

 

The dollar cost of ouroperations in Israel is heavily influenced by changes in the value of thedollar in relation to the New Israel Shekel (“NIS”), mostly due to theNIS-based salaries of our Israel-based employees. In the three months ended September 30,2008, the average value of the dollar declined approximately 17%, as comparedto its value during the same period in 2007. In the nine months ended September 30,2008, the average value of the dollar declined approximately 16%, as comparedto its value during the same period in 2007. During the three and nine monthsending September 30, 2008, approximately $1.6 million and $4.9 million ofour expenses, respectively, were NIS-based, thus the devaluation noted above,significantly influenced our operating expenses. While hedging activitiessomewhat reduced the impact of the devaluation of the dollar during thoseperiods, we absorbed most of the devaluation.

 

***Write-off of the Brainboost Answer Engine***

 

InDecember 2005, we acquired Brainboost Technology, LLC, developer of theBrainboost Answer Engine, or the BAE, an artificial intelligence technologyenabling natural language question-and-answer search on the Web.  As consideration for the acquisition, we paid$4.0 million in cash and 439,000 shares of its restricted stock, valued atapproximately $5.6 million at the time of the acquisition. In connection withthe initial allocation of the purchase price, we recorded an intangible asset,the BAE, with an estimated useful life of six years, of approximately $5.4million.  Since the acquisition, through the first quarter of 2008, wespent time further developing the BAE and integrating it into our Answers.comWeb property.

 

InNovember 2006, we acquired a Web property, then known as www.faqfarm.com,and subsequently rebranded as WikiAnswers.com, a dynamic, user-generated,questions and answers website. Although handled in different ways, BAE andWikiAnswers are effectively focused on similar areas, answering complex naturallanguage questions. Since its acquisition, WikiAnswers has grown significantly,each quarter, both in terms of traffic and revenue. Conversely, during thatperiod, Answers.com traffic and revenue has generally declined each quarter.Detailed information regarding these trends is provided in the revenuediscussion in this quarterly report. As a result of this continued trend, andthe success of user-generated questions and answers as compared to the technology-drivenanswers presented by the BAE, we made a strategic decision in the secondquarter of 2008 to focus our efforts, in the realm of questions-and-answers, onuser-generated questions and answers, and effectively abandoned our use of theBAE. This strategic decision was reflected in a change we made to Answers.comon May 25, 2008.  Prior to thatdate, users asking a question on Answers.com caused the site to access the BAEin an attempt to locate an answer on the Web. The BAE results were then presented on the Answers.com result page.Beginning May 25, 2008, users no longer receive BAE-derived result pages,rather they are instead encouraged to post their question to WikiAnswers, andin a less pronounced fashion, offered a link to another page for purposesof accessing BAE should they wish to do so. This user-interface changevirtually eliminated the use of the BAE as demonstrated by the elimination ofvirtually all BAE-derived page views.

 

Asa result of our decision to effectively abandon our use of the BAE, the netbook value of the BAE, as of May 25, 2008, in the amount of $3.138million, was written off during the three months ended June 30, 2008.

 

***Termination fees and write-off of costrelating to the terminated Lexico acquisition and abandoned follow-on offering***

 

In the first quarter of2008, we recorded a charge of $2,543 thousand consisting of $1,618 thousand ofaccounting, legal, banking, consulting and travel costs we incurred in 2007 and inthe first quarter of 2008, inconnection with the abandoned acquisition of Lexico and follow-on offering ofsecurities, and $925 thousand relating to termination fees we paid as a resultof the termination of the acquisition and a Securities Purchase Agreement withan institutional investor, for the optional purchase and sale of$8.5 million of our senior secured convertible notes. A summary of theevents that led to the termination of the acquisition and financing follows:

 

On July 13, 2007, weentered into a Purchase Agreement that we subsequently amended on July 31,2007 and November 12, 2007, and on January 15, 2008 we entered intoan Amended and Restated Purchase Agreement, which we subsequently amended on February 8,2008, to acquire all of the outstanding limited liability interests of LexicoPublishing Group, LLC for an aggregate purchase price of $100 million incash, subject to adjustments for closing net working capital.  Consummation of the acquisition of Lexico wassubject to our ability to secure financing for the acquisition.

 

On July 17, 2007, we fileda universal shelf registration statement on Form S-3 with the Securitiesand Exchange Commission which was 

 

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declared effective on August 6,2007.  The registration statement coversup to an aggregate of $140 million of common stock, preferred stock, warrants,debt securities, units or any combination thereof. On January 16, 2008, wefiled a prospectus supplement for a proposed public offering which we lateramended on February 8, 2008.  On February 13,2008 we canceled our proposed public offering due to unfavorable marketconditions. On March 1, 2008, the members of Lexico terminated thepurchase agreement, due to our inability to finance the acquisition.  Additionally, in connection with the Lexicotransaction, on January 15, 2008, we entered into a Securities PurchaseAgreement with an institutional investor, or the senior notes investor, for theoptional purchase and sale of $8.5 million of our senior securedconvertible notes. Our intent was to close the senior secured convertible notesfinancing in conjunction with our follow-on offering, if we needed such fundsto close the Lexico acquisition. Since our purchase agreement with Lexico wasterminated, the Securities Purchase Agreement also terminated.

 

***Interest Income (Expense), Net***

 

Interest income, net, iscomprised of interest income earned on cash, cash equivalent and an investmentsecurity balances, and amortization of deferred costs we incurred in connectionwith the issuance of the Series B Unit Warrant.

 

***Other Income (Expenses), Net***

 

Other income (expenses),net, consists primarily of foreign currency exchange gains and losses.

 

***Loss Resulting from Fair Value Adjustment of Warrant to Purchase Unitsof Series B Preferred Stock and Warrants Discuss***

 

The Series B UnitWarrant is revalued each reporting date. Any change to its fair value isrecorded in the statement of operations.

 

***Income Tax Expense***

 

Our effective tax ratediffers from the statutory federal rate due to differences between income andexpense recognition prescribed by income tax regulations and Generally AcceptedAccounting Principles. We utilize different methods and useful lives for depreciatingand amortizing property, equipment and intangible assets and different methodsand timing for calculating and recording stock compensation expense and otheraccruals. Furthermore, permanent differences arise from certain income andexpense items recorded for financial reporting purposes but not recognizablefor income tax purposes. In addition, our income tax expense has been adjustedfor the effect of state and local taxes and foreign income from our whollyowned subsidiary. Our deferred tax assets are primarily offset by a valuationallowance because realization depends on generating future taxable income,which, in our estimation, is not more likely than not to transpire.

 

OurIsraeli subsidiary had income in the three and nine months ended September 30,2008 and 2007, resulting from the services agreement we entered into with suchIsraeli subsidiary. Pursuant to this agreement, the Israeli subsidiary chargesus for research and development services it provides us, plus a profit marginnot more than 12.5%. However, the subsidiary is an “approved enterprise” underIsraeli law, which means that income arising from the subsidiary’s approvedactivities, is subject to zero tax under the “alternative benefit” path for aperiod of ten years. Currently, the subsidiary operates under two separate “approvedenterprise” plans, ending December 31, 2009 and December 31, 2014,respectively. In the event of distributions by the subsidiary to the parent,the subsidiary would have to pay a 10% corporate tax on the amount distributed,and the recipient would have to pay a 15% tax to be withheld at source on theamounts of such distribution received. At present, we do not plan on having thesubsidiary distribute a dividend to Answers Corporation.

 

***Three Months and Nine Months Ended September 30,2008 and 2007***

 

*Revenue*

 
| ** **                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                         | ** ** | **($ - in thousands)**                | ** ** | **($ - in thousands)**               | ** ** |
|                               |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Answers.com advertising revenue    |       | 1,579                                                |       | 1,861                                               |       | (282 | ) | 4,891 |   | 7,179 |   | (2,288 | ) |
| WikiAnswers advertising revenue    |       | 1,960                                                |       | 304                                                 |       | 1,656 |   | 4,645 |   | 598 |   | 4,047 |   |
| Answers services licensing revenue |       | 24                                                   |       | 43                                                  |       | (19 | ) | 61 |   | 202 |   | (141 | ) |
| Subscription revenue               |       |                                                 |       | —                                              |       |   |   | — |   | 425 |   | (425 | ) |
|                               |       | 3,563                                                |       | 2,208                                               |       | 1,355 |   | 9,597 |   | 8,404 |   | 1,193 |   |

 

Revenue increased $1,355thousand, or 61%, to $3,563 thousand for the three months ended September 30,2008 from $2,208 thousand for the three months ended September 30, 2007.

 

 Answers.com advertising revenue for the threemonths ended September 30, 2008 decreased $282 thousand compared to thethree months ended September 30, 2007. The decrease was the result ofdecreased traffic, which was only partially mitigated by very moderateimprovement 

 

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in RPM.  Answers.com average daily page views inthe three months ended September 30, 2008 were 2,666,000, a decline of 19%compared to the average daily page views of 3,276,000 in the three monthsended September 30, 2007. The decline in traffic is primarily due to the July 2007Google algorithm change that significantly impacted Answers.com traffic,reducing our overall traffic by approximately 28% based on the average trafficdirected to Answers.com from Google for the week prior to the adjustment ascompared to the week after. As a result, our revenue also declinedproportionately. The Answers.com RPM in the three months ended September 30,2008 was $6.44, an increase of 4% compared to the RPM of $6.17 in the threemonths ended September 30, 2007. We have found that this metric oftenmoves up or down moderately due to many factors including how we are evaluatedby our advertising partners.

 

Answers.com advertisingrevenue for the nine months ended September 30, 2008 decreased $2,288thousand compared to the nine months ended September 30, 2007, mostly dueto decreases in traffic.  Answers.comaverage daily page views in the nine months ended September 30, 2008were 2,844,000, a decline of 33%compared to the average daily page views of 4,221,000 in the nine monthsended September 30, 2007. The decline in traffic is primarily due to the July 2007Google algorithm change that significantly impacted Answers.com traffic,reducing our overall traffic by approximately 28% based on the average trafficdirected to Answers.com from Google for the week prior to the adjustment ascompared to the week after. As a result, our revenue also declinedproportionately. The Answers.com RPM in the nine months ended September 30,2008 was $6.28, an increase of 1% compared to the RPM of $6.23 in the ninemonths ended September 30, 2007.

 

Since the Google adjustment,we suspended our Answers.com strategy of licensing new content, and,consequently, we have generally experienced quarterly declines in Answers.comtraffic. Historically, we operated on the premise that adding rich uniquecontent to Answers.com positively impacted the site’s traffic growth, guided bythe principle that rich unique content was not only appreciated by the humanuser, rather, it was also highly valued by the search engines and their contentindexing programs. While Answers.com receives significant SEO traffic to itsrich content pages, the Google algorithm change caused us to doubt whetherlicensing additional content would yield a positive return. In recent months wemade certain changes to and ran certain tests on Answers.com that have led usto believe that adding content may, once again, be a viable way to growtraffic. While we intend to rejuvenate the Answers.com content strategy,, thereis no assurance we will succeed in achieving renewed growth for Answers.com.

 

WikiAnswers.com advertisingrevenue for the three months ended September 30, 2008 increased $1,656thousand compared to the three months ended September 30, 2007, due toincreases in traffic, and to a lesser extent, due to improvement in RPM.  WikiAnswers.com average daily page viewsin the three months ended September 30, 2008 were 3,094,000, an increaseof 384% compared to the average daily page views of 639,000 in the threemonths ended September 30, 2007. We believe that the dramatic growth thatWikiAnswers has experienced since we acquired it, in November 2006, isprimarily due to the unique dynamics of the site. As our database of questionsand answers grows, we draw new traffic, primarily from SEO, which in turnresults in the creation of new questions and answers, or new content, which inturn drives additional growth. This is a self-perpetuating growth model. TheWikiAnswers.com RPM during those periods rose from $5.17 to $6.89, primarilydue to the inclusion of WikiAnswers under our Google Services Agreement,replacing the standard AdSense terms that governed the site prior to ouracquisition of WikiAnswers.

 

WikiAnswers.com advertisingrevenue for the nine months ended September 30, 2008 increased $4,047thousand compared to the nine months ended September 30, 2007, due toincreases in traffic, and to a lesser extent, due to improvement in RPM.  WikiAnswers.com average daily page viewsin the nine months ended September 30, 2008 were 2,432,000, an increase of432% compared to the average daily page views of 457,000 in the ninemonths ended September 30, 2007. We believe that the dramatic growth thatWikiAnswers has experienced since we acquired it, in November 2006, isprimarily due to the unique dynamics of the site. As our database of questionsand answers grows, we draw new traffic, primarily from SEO, which in turnresults in the creation of new questions and answers, or new content, which inturn drives additional growth. This is a self-perpetuating growth model. TheWikiAnswers.com RPM during those periods rose from $4.78 to $6.97, primarilydue to the inclusion of WikiAnswers under our Google Services Agreement,replacing the standard Adsense agreement that was entered into prior to ouracquisition of WikiAnswers.

 

Approximately$187 thousand and $256 thousand of our advertising revenue in the three monthsended September 30, 2008 and 2007, respectively, resulted from the effortsof our direct ad sales force. Approximately $618 thousand and $415 thousand ofour advertising revenue in the nine months ended September 30, 2008 and2007, respectively, resulted from the efforts of our direct ad salesforce.  In an effort to improvemonetization, in the fourth quarter of 2006, we began marketing directly toadvertisers and generating additional advertising revenue. However, at the endof the second quarter of 2008 we decided to abandon that effort, and by the endof the third quarter of 2008, all of our direct sales staff left the Company.The direct ad revenue earned in the third quarter of 2008 relates mostly tocampaigns that commenced before we decided to terminate our direct ad salesefforts.

 

Subscription revenue in thenine months ended September 30, 2007 of $425 thousand resulted from therecognition of revenue from the sale of lifetime subscriptions to our GuruNetservice prior to December 2003. As of December 31, 2006, we hadapproximately $425 thousand of deferred revenue relating to thesesubscriptions. Prior to 2007, we did not recognize any revenue from thelifetime subscriptions to our GuruNet service because the subscriptions had nodefined term. On February 2, 2007, in accordance with our rights under theagreements we entered into with such subscribers, we terminated the GuruNetservice and thereby extinguished our service obligations to our subscribers. Asa result, we recognized the entire $425 thousand previously deferred, asrevenue, in the first quarter of 2007. After the launch of Answers.com in January 2005,we ceased offering new subscriptions to GuruNet.

 

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***Revenue Trends by Web Property***

 

The following tableillustrates the historical trends of our two Web properties’ average dailytraffic, revenues and RPMs, by quarter, beginning the first quarter of 2007:

 
| ** **                             | ** ** | **2007**      | ** ** | **2008**      | ** ** |
|----------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                             | ** ** | **Q1**        | ** ** | **Q2**        | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Q1** | ** ** | **Q2** | ** ** | **Q3** | ** ** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| **Ad Revenue ($ - in thousands)** |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| Answers.com                            |       | 2,768         |       | 2,551         |       | 1,861 |   | 2,270 |   | 1,828 |   | 1,485 |   | 1,579 |   |
| WikiAnswers                            |       | 116           |       | 177           |       | 304 |   | 704 |   | 1,185 |   | 1,500 |   | 1,960 |   |
| **Total**                              | ** ** | **2,884**     | ** ** | **2,728**     | ** ** | **2,165** | ** ** | **2,974** | ** ** | **3,013** | ** ** | **2,985** | ** ** | **3,539** | ** ** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| Answers.com                            |       | 96            | %          | 94            | %          | 86 | % | 76 | % | 61 | % | 50 | % | 45 | % |
| WikiAnswers                            |       | 4             | %          | 6             | %          | 14 | % | 24 | % | 39 | % | 50 | % | 55 | % |
| **Total**                              | ** ** | **100**       | **%**      | **100**       | **%**      | **100** | **%** | **100** | **%** | **100** | **%** | **100** | **%** | **100** | **%** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| **Traffic**                            |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| Answers.com                            |       | 4,945,000     |       | 4,441,000     |       | 3,276,000 |   | 3,447,000 |   | 3,225,000 |   | 2,641,000 |   | 2,666,000 |   |
| WikiAnswers                            |       | 293,000       |       | 440,000       |       | 639,000 |   | 1,152,000 |   | 1,885,000 |   | 2,318,000 |   | 3,094,000 |   |
| **Total**                              | ** ** | **5,238,000** | ** ** | **4,881,000** | ** ** | **3,915,000** | ** ** | **4,599,000** | ** ** | **5,110,000** | ** ** | **4,959,000** | ** ** | **5,760,000** | ** ** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| Answers.com                            |       | 94            | %          | 91            | %          | 84 | % | 75 | % | 63 | % | 53 | % | 46 | % |
| WikiAnswers                            |       | 6             | %          | 9             | %          | 16 | % | 25 | % | 37 | % | 47 | % | 54 | % |
| **Total**                              | ** ** | **100**       | **%**      | **100**       | **%**      | **100** | **%** | **100** | **%** | **100** | **%** | **100** | **%** | **100** | **%** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| **RPM**                                |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| Answers.com                            |       | $             | 6.22       |          | $          | 6.31 |   | $ | 6.17 |   | $ | 7.16 |   | $ | 6.23 |   | $ | 6.18 |   | $ | 6.44 |   |
| WikiAnswers                            |       | $             | 4.40       |          | $          | 4.42 |   | $ | 5.17 |   | $ | 6.64 |   | $ | 6.95 |   | $ | 7.11 |   | $ | 6.89 |   |

 

Since we purchased WikiAnswersin November 2006, the website has grown significantly, each quarter, bothin terms of traffic and revenue. Conversely, in 2007, and especially beginningthe third  quarter of 2007, when weexperienced a drop in our traffic due to a search engine algorithm adjustmentby Google, Answers.com’s quarterly traffic and revenue has generally declined.We expect the aforesaid trends of our individual Web properties to continueduring the remainder of 2008.

 

The uncertain U.S. andglobal consumer spending environment may have a significant negative impact onthe RPM of both our Web properties in the fourth quarter of 2008, in 2009, andbeyond. While CPM rates are showing decline, it is still uncertain whether CPCrates for performance-based ads, which represents the vast majority of ouradvertising revenue, will be impacted. We do not expect the environment will affect our expected overall growthin traffic.

 

**Costs andExpenses**

 

***Cost of Revenue***

 
| ** **      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **      | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **      | ** ** | **($ - in thousands)**                | ** ** | **($ - in thousands)**               | ** ** |
|            |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Cost of revenue |       | 945                                                  |       | 1,179                                               |       | (234 | ) | 3,754 |   | 3,643 |   | 111 |   |

 

Cost of revenue decreased$234 thousand, or 20%, to $945, in the three months ended September 30,2008 from $1,179 in the three months ended September 30, 2007. The changein cost of revenue was due primarily to the following factors. Amortizationexpense from intangible technology assets we purchased in connection with theBrainboost acquisition that took place in December 2005 and theWikiAnswers acquisition that took place in November 2006 decreased. Sincewe wrote off the Brainboost Answer Engine on May 25, 2008, we eliminated$223 thousand of quarterly amortization, in the three months ended September 30,2008 as compared to the three months ended September 30, 

 

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2007. The amortization ofthe intangible assets related to WikiAnswers decreased by $15 thousand in thethree months ended September 30, 2008, as compared to the three monthsended September 30, 2007, since some of the assets we purchased are nowfully amortized. Also, there was a decrease in data center costs (includingdepreciation of information technology assets) of $150 thousand, due to ourmoving to our own collocation facility rather than managed hosting. In acollocation facility, many of the tasks that were handled by the managedhosting provider are now handled by our employees, thus the fees we pay arelower. The aforesaid decreases were partially offset by increases incompensation costs of $136 thousand as a result of staffing additions, salaryincreases and the weak U.S. dollar as compared to the Israel shekel.

 

Cost of revenue increased$111 thousand, or 3%, to $3,754, in the nine months ended September 30,2008 from $3,643 in the nine months ended September 30, 2007. The changein cost of revenue was due primarily to the following factors. Compensationcosts increased $265 thousand as a result of staffing additions, salaryincreases and the weak U.S. dollar as compared to the Israel shekel.Additionally, we experienced increases in traffic acquisition costs of $22thousand, increases in ad serving fees of $33 thousand, increases in travel of$23 thousand, increases in content licensing costs of $36 thousand, increasesin outside consulting and general services of $30 thousand, and increases inoverhead of $23 thousand. Recruitment fees in the nine months ended September 30,2008 were $29 thousand, where no such expense was incurred in the nine monthsended September 30, 2007. The aforesaid increases were partially offset bya reduction in amortization expense. Amortization expense results fromintangible assets we purchased in connection with the Brainboost acquisitionthat took place in December 2005 and the WikiAnswers acquisition that tookplace in November 2006. The amortization of the Brainboost technologydecreased by $312 thousand, as it was written off on May 25, 2008. Theamortization of the intangible assets related to WikiAnswers decreased by $46thousand in the nine months ended September 30, 2008, since some of theassets we purchased are now fully amortized.

 

***Research and Development Expenses***

*** ***
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **               | ** ** | **($ - in thousands)**                | ** ** | **($ - in thousands)**               | ** ** |
|                     |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Research and development |       | 866                                                  |       | 769                                                 |       | 97 |   | 2,670 |   | 2,239 |   | 431 |   |

 

Research and developmentexpenses increased $97 thousand, or 13%, to $866 thousand in the three monthsended September 30, 2008 from $769 thousand in the three months ended September 30,2007. The change in research and development expenses was due primarily to anincrease of $103 thousand in compensation, as a result of salary increases andthe weak U.S. dollar as compared to the Israel shekel.

 

Research and developmentexpenses increased $431 thousand, or 19%, to $2,670 thousand in the nine monthsended September 30, 2008 from $2,239 thousand in the nine months ended September 30,2007. The change in research and development expenses was due primarily to anincrease of $408 thousand in compensation-related expenses as a result ofstaffing additions, salary increases and the weak U.S. dollar as compared tothe Israel shekel.

 

***Sales and Marketing Expenses***

 
| ** **          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **          | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **          | ** ** | **($ - in thousands)**                | ** ** | **($ - in thousands)**               | ** ** |
|                |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Sales and marketing |       | 563                                                  |       | 1,221                                               |       | (658 | ) | 2,258 |   | 3,275 |   | (1,017 | ) |

 

Sales and marketing expensesdecreased $658 thousand or 54%, to $563 thousand during the three months ended September 30,2008 from $1,221 thousand during the three months ended September 30,2007. The change in sales and marketing expenses is due primarily to a decreasein compensation related expenses, excluding stock-based compensation, of $429thousand, and a decrease in stock-based compensation of $184 thousand. Thesedecreases resulted mostly from the termination of employment of our ChiefRevenue Officer in the third quarter of 2007 and our direct ad sales team inthe second and third quarter of 2008.

 

Sales and marketing expensesdecreased $1,017 thousand or 31%, to $2,258 thousand during the nine monthsended September 30, 2008 from $3,275 thousand during the nine months endedSeptember 30, 2007. The change in sales and marketing expenses is dueprimarily to the following factors. Compensation related expenses, excludingstock-based compensation, decreased $527 thousand, and stock-based compensationdecreased $495 thousand. These decreases resulted mostly from the terminationof employment of our Chief Revenue Officer in the third quarter of 2007 and ourdirect ad sales team in the second and third quarter of 2008. The terminationof our direct ad sales team also resulted in a reduction of $33 thousand inallocated overhead expenses, and advertising and marketing related expensesdecreased $44 thousand. Additionally, recruitment fees in the nine months endedSeptember 30, 2007 were $48 thousand, where no such expense was incurredin the nine months ended September 30, 2008. The aforesaid decreases werepartially offset by a charge of $132 thousand, in the second quarter of 2008,to account for the estimated cost of terminating certain service contractsrelating to our abandoned direct ad sales efforts.

 

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***General and Administrative Expenses***

 
| ** **                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **($ - in thousands)**                | ** ** | **($ - in thousands)**               | ** ** |
|                       |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| General and administrative |       | 1,311                                                |       | 1,058                                               |       | 253 |   | 3,640 |   | 3,003 |   | 637 |   |

 

General and administrativeexpenses increased $253 thousand, or 24%, to $1,311 thousand during the threemonths ended September 30, 2008 from $1,058 thousand during the three monthsended September 30, 2007. The change in general and administrativeexpenses was due primarily to the following factors. Stock administration feesrose $40 thousand due mostly to the fact that our annual meeting ofstockholders, in 2008, took place in the third quarter, rather than the secondquarter, as was the case in 2007. Compensation costs increased by $54 thousandas a result of salary increases and the weak U.S. dollar as compared to theIsrael shekel. There were also increases in travel of $44 thousand, overhead of$49 thousand, and accounting and legal fees of $64 thousand.

 

General and administrativeexpenses increased $637 thousand, or 21%, to $3,640 thousand during the ninemonths ended September 30, 2008 from $3,003 thousand during the nine monthsended September 30, 2007. The change in general and administrativeexpenses was due primarily to the following factors. Compensation costsincreased by $310 thousand as a result of staffing additions, salary increasesand the weak U.S. dollar as compared to the Israel shekel. Accounting and legalfees increased $123 thousand due to the Redpoint Financing and other issuesthat rose during the nine months ended September 30, 2008.  There were also increases in stockadministration fees of $54 thousand, in travel of $29 thousand, and insuranceof $60 thousand.

 

***Write-off of the Brainboost Answer Engine***

*** ***
| ** **                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                                | ** ** | **($ - in thousands)**                | ** ** | **($ - in thousands)**               | ** ** |
|                                      |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Write-off of the Brainboost Answer Engine |       | —                                               |       | —                                              |       | — |   | 3,138 |   | — |   | 3,138 |   |

 

Asa result of our decision to effectively abandon our use of the BAE, the netbook value of the BAE, as of May 25, 2008, in the amount of $3,138thousand, has been written off and the resulting charge is included in ourstatement of operations for the nine months ended September 30, 2008.

 

***Termination fees and write-off of costsrelating to the terminated Lexico acquisition and abandoned follow-on offering***

*** ***
| ** **                                                                                                               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                               | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                                                                                                               | ** ** | **($ - in thousands)**                | ** ** | **($ - in thousands)**               | ** ** |
|                                                                                                                     |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Termination fees and write-off of costs  relating to the terminated Lexico acquisition and abandoned follow-on  offering |       | —                                               |       | —                                              |       | — |   | 2,543 |   | — |   | 2,543 |   |

 

During the nine months endedSeptember 30, 2008, we recorded a charge of $2,543 thousand for variouscosts and fees we incurred in connection with the terminated acquisition ofLexico and the follow-on offering of securities.

 

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***Interest (Expense) Income, Net***

 
| ** **                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                     | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                     | ** ** | **($ - in thousands)**                | ** ** | **($ - in thousands)**               | ** ** |
|                           |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Interest (expense) income, net |       | (43                                                  | )          | 88                                                  |       | (131 | ) | 30 |   | 299 |   | (269 | ) |

 

Interest (expense) income,net decreased $131 thousand to $(43) thousand, net, for the three months ended September 30,2008 from $88 thousand income, net, for the three months ended September 30,2007. The change in interest (expense) income, net resulted from certaintransaction costs that we incurred in connection with the Series B UnitWarrant, which have been deferred and are being amortized to interest expenseover one year. During the three months ended September 30, 2008, $91thousand of such deferred costs were amortized and charged to interest expense.Further, interest earned from our cash balance during the three months ended September 30,2008 of $48 thousand, as compared to interest earned during the three monthsended September 30, 2007, of $88 thousand. The reduction in interestincome earned on our cash balances was the result of significantly lowershort-term interest rates.

 

Interest income, netdecreased $269 thousand, or 90%, to $30 thousand for the nine months ended September 30,2008 from $299 thousand for the nine months ended September 30, 2007. Thechange in interest income resulted from certain transaction costs that weincurred in connection with the Series B Unit Warrant, which have beendeferred and are being amortized to interest expense over one year. During thenine months ended September 30, 2008, $106 thousand of such deferred costswere amortized and charged to interest expense. Further, interest earned fromour cash balance during the nine months ended September 30, 2008 was $136thousand, as compared to interest earned from cash balances during the ninemonths ended September 30, 2007, of $299 thousand. The reduction ininterest income earned on our cash balances was the result of significantlylower short-term interest rates.

 

***Loss Resulting from Fair Value Adjustment of Warrant to Purchase Unitsof Series B Preferred Stock and Warrants***

 

***Discuss***

 
| ** **                                                                                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                                                                                                            | ** ** | **($ - in thousands)**                | ** ** | **($ - in thousands)**               | ** ** |
|                                                                                                                  |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Loss Resulting from Fair Value Adjustment  of Warrant to Purchase Units of Series B Preferred Stock and Warrants |       | (2,056                                               | )          | —                                              |       | (2,056 | ) | (2,056 | ) | — |   | (2,056 | ) |

 

The Series B UnitWarrant is revalued each reporting date, and any change to its fair value isrecorded in the statement of operations. The primary reason for the increase inthe value of this liability during the three months ended September 30,2008, was the increase in the market value of our common stock between June 30,2008 and September 30, 2008.

 

***Other Income (Expenses), Net***

 
| ** **                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                  | ** ** | **($ - in thousands)**                | ** ** | **($ - in thousands)**               | ** ** |
|                        |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |
| Other income (expense), net |       | 11                                                   |       | —                                              |       | 11 |   | (38 | ) | (11 | ) | (27 | ) |

 

Other income, net, duringthe three months ended September 30, 2008 was $11 thousand, compared to $0in the three months ended September 30, 2007. Other income, net, in thethird quarter of 2008 resulted from foreign currency exchange net gains.

 

Other expense, net increased$27 thousand, to $38 thousand for the nine months ended September 30, 2008from $11 thousand for the nine months ended September 30, 2007. Otherexpenses, net, in the nine months ended September 30, 2008 resulted fromforeign currency exchange net losses.

 

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***Income Tax Benefit (Expense)***

 

We had net operating losscarryforwards, or NOLs, for federal income tax purposes of approximately $54million at December 31, 2007, and approximately $49 million at December 31,2006. The federal net operating losses will expire if not utilized on variousdates from 2019 through 2027. Because we have experienced one or more ownershipchanges, within the meaning of Section 382 of the Internal Revenue Code of1986, as amended, an annual limitation is imposed on our ability to use atleast $32 million of these carryforwards. Our best estimate at this timeis that the annual limitation on the use of at least $32 million of ourNOLs is approximately $1.8 million per year. Any unused portion of the$1.8 million annual limitation applicable to our restricted NOLs isavailable for use in future years until such NOLs are scheduled to expire. Therecent Redpoint Financing may further impact our ability to use our NOLs,however, since we have not conducted a Section 382 Study since we receivedthe Redpoint Financing we cannot make that determination. Our Israelisubsidiary has capital loss carryforwards of approximately $800 thousandthat can be applied to future capital gains for an unlimited period of timeunder current tax rules.

 

In September 2008, the Israeli income taxauthorities completed its audit of our Israeli subsidiary for the tax years2004 through 2006, resulting in no adjustments, pending final approval. As aresult of the findings of such audit, the Company reversed previously accruedtax provisions during the third quarter of 2008.

 

**Liquidityand Capital Resources**

 

Ourprincipal sources of liquidity are cash and cash equivalents, which were $9,653thousand as of September 30, 2008. In the nine months ended September 30,2008, our cash used in operations was $2,759 thousand. We have used cash in ouroperations in virtually every quarter since our inception. Our ability togenerate cash from operations in the future will depend primarily on ourability to produce net income before non-cash expenses such as depreciation andamortization and stock-based compensation.

 
| ** **                                | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **($ - in thousands)**                   | ** ** |
|                                      |       |                                                    |       |   |   |
| Net cash used in operating activities     |       | (2,705                                                  | )          | (422 | ) |
| Net cash provided by investing activities |       | 237                                                     |       | 703 |   |
| Net cash provided by financing activities |       | 5,307                                                   |       | 36 |   |

 

***Operating Activities***

 

Despite a net loss of$10,405 thousand in the nine months ended September 30, 2008, net cashused in operations was $2,705 thousand. The adjustments to reconcile the twoamounts, including changes to the balances of our various operating assets andliabilities, are noted in detail on the accompanying statement of cash flows.The largest reconciling items are the write-off of the Brainboost AnswersEngine of $3,138 thousand, the loss resulting from the fair value adjustment ofthe Series B Unit Warrant of $2,056 thousand, $1,312 thousand of operatingexpenses that were the result of non-cash, stock-based compensation toemployees and directors, depreciation and amortization of $1,080 thousand, andthe write-off of amounts that were paid in prior periods relating to theterminated Lexico acquisition and abandoned follow-on offering, of $663thousand.

 

***Investing Activities***

 

Net cash provided byinvesting activities in the nine months ended September 30, 2008 and 2007,is attributable mostly to the proceeds from the sale of investment securities,less cash used for purchases of investment securities, and cash used forcapital expenditures, as delineated in our Consolidated Statements of CashFlows.

 

***Financing Activities***

 

Net cash flow from financingactivities in the nine months ended September 30, 2008 was almost entirelyfrom the Redpoint Financing. Cash flow from financing activities in the ninemonths ended September 30, 2007 resulted from the exercise of stockoptions, less amounts used on certain deferred financing charges.

 

***Future Operations***

 

As a result of the RedpointFinancing, in June 2008, we raised net proceeds of approximately $5.4million, significantly improving our cash position. As part of the RedpointFinancing, Redpoint received the Series B Unit Warrant, a warrant topurchase units, exercisable at any time until June 16, 2009, for up to $7million of Series B Convertible Preferred Stock and Series B PurchaseWarrants.   The Series APreferred Stock contains a redemption provision which allows the holder of amajority of the Series A Preferred Stock to request redemption, at anytime on or after June 16, 2014, of all or any part of the outstanding Series APreferred Stock.  If issued, the Series BPreferred Stock would have a similar redemption provision.

 

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The funding we alreadyreceived from Redpoint is important to us because of prior events that broughtour cash position down considerably. In connection with the abandoned proposedpublic offering and the terminated Lexico purchase agreement, we made cashpayments of $1,878 thousand in the first quarter of 2008, in addition to the$665 thousand we expended in 2007, for termination fees and costs.  These payments had a material impact on thebalance of our cash and cash equivalents, which were $5,462 thousand as of March 31,2008.

 

We believe we havesufficient cash to meet our planned operating needs for the next twelve months,based on our current cash levels and expected cash flow from operations.  Further, in estimating our expected cash flowduring the next twelve months we have considered the uncertain U.S. and globalconsumer spending environment and its impact on our future revenue, asdiscussed in the earlier revenue discussion. Notwithstanding, our businessstrategy includes growth through additional business combinations and licensingor acquiring products and technologies complementary to our business, whichcould require use of a significant amount of our available cash. We maytherefore need to raise additional capital through future debt or equity financingto finance such initiatives. However, we cannot be certain that additionalfinancing will be available on acceptable terms, or at all. To the extent thatwe raise additional funds by issuing equity securities, our stockholders mayexperience significant dilution.

 

**ContractualObligations and Commitments**

 

As of September 30,2008, we had the following known contractual obligations and commitments ($ -in thousands):

 
| ** **                                        | ** ** | **Purchase  Contracts** | ** ** | **Capital  Leases** | ** ** | **Operating  Leases** | ** ** | **Total(1)** | ** ** |
|---------------------------------------------------|------------|-------------------------|------------|---------------------|------------|-----------------------|------------|--------------|------------|
|                                              |       |                    |       |                |       |                  |       |         |       |
| 2008 (three months ending December 31, 2008) |       | 186                     |       | 19                  |       | 142                   |       | 347          |       |
| 2009                                              |       | 420                     |       | 78                  |       | 507                   |       | 1,005        |       |
| 2010                                              |       | 105                     |       | 82                  |       | 309                   |       | 496          |       |
| 2011                                              |       | —                  |       | 24                  |       | 11                    |       | 35           |       |
|                                              |       |                    |       |                |       |                  |       |         |       |
|                                              |       | 711                     |       | 203                 |       | 969                   |       | 1,883        |       |

 

----

(1)                                  The above table does not include unrecognizedtax benefits of $70 thousand.

 

**Off-BalanceSheet Arrangements**

 

We have not entered into anytransactions with unconsolidated entities in which we have financialguarantees, subordinated retained interests, derivative instruments or othercontingent arrangements that expose us to material continuing risks, contingentliabilities or any other obligations under a variable interest in anunconsolidated entity that provides us with financing, liquidity, market riskor credit risk support.

 

**Quantitativeand qualitative disclosures about market risk**

 

*CurrencyRisk.*  Ourrevenue is denominated solely in U.S. dollars. Most of our expenses arealso based in U.S. dollars, however, a very significant portion of ourexpenses are denominated in New Israel Shekels, or NIS. We expectthis level of NIS expenses to continue for the foreseeable future. In 2007, thevalue of the U.S. dollar weakened against the value of NIS by 9%, and itweakened an additional 11% during the nine months ending September 30,2008. If the value of the U.S. dollar further weakens against the value ofNIS, there will be a negative impact on our results of operations. In addition,to the extent we hold cash and cash equivalents that are denominated incurrencies other than the U.S. dollar, we are subject to the risk ofexchange rate fluctuations. We use various hedging tools, including forwardcontracts and options, to lessen the effect of currency fluctuations on ourincome.

 

*OtherMarket Risk.*  As of September 30, 2008, all of our excess cash was invested in money market accounts that we believe have no material exposure to theprincipal amount nor to interest rate risk. Historically, we didinvest much of our excess cashin various highly liquid investments including auction rate, investment grade,corporate and municipal debt instruments, and auction rate preferred shares ofclosed-end investment funds that invest in long-term fixed income securities,with auction reset periods (“ARS’s”) of 28 days. Recently, many holders ofARS instruments have experienced liquidity difficulties due to the lack ofsufficient demand for the securities on the reset dates. While we did hold someARS’s as of December 31, 2007, we sold all our interests in the firstquarter of 2008 and did not experience a loss upon such sales.  Currently, we do not own any ARS’s, and wehave ceased making any investments in ARS’s.

 

**CriticalAccounting Estimates**

 

While our significantaccounting policies are more fully described in the notes to our auditedconsolidated financial statements for the years ended December 31, 2007and 2006, and our consolidated financial statements for the three months andnine months ended September 30, 2008 and 2007, we believe the followingaccounting policies to be the most critical in understanding the judgments andestimates we use in preparing our consolidated financial statements.

 

***Goodwill, Intangibles and Other Long-Lived Assets***

 

We account for our purchasesof acquired companies in accordance with SFAS No. 141, “BusinessCombinations,” or SFAS 141, and for goodwill and other identifiable definiteand indefinite-lived acquired intangible assets in accordance with SFAS No.142, “Goodwill and Other 

 

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Intangible Assets,” or SFAS 142. Additionally, we review ourlong-lived assets for recoverability in accordance with SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” orSFAS 144.

 

The identification andvaluation of intangible assets and the determination of the estimated usefullives at the time of acquisition are based on various valuation methodologiesincluding reviews of projected future cash flows. The use of alternativeestimates and assumptions could increase or decrease the estimated fair valueof our goodwill and other intangible assets, and potentially result in adifferent impact to our results of operations. Further, changes in businessstrategy and/or market conditions may significantly impact these judgmentsthereby impacting the fair value of these assets, which could result in animpairment of the goodwill and acquired intangible assets.

 

We evaluate our long-livedtangible and intangible assets for impairment in accordance with SFAS 142,“Goodwill and Other Intangible Assets,” with the annualimpairment testing date set at September 30, and in accordance with SFAS 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. If such assets are considered to be impaired, the impairment tobe recognized is measured by the amount by which the carrying amount of theassets exceeds the fair value of the assets. While we use available informationto prepare our estimates and to perform impairment evaluations, the completionof annual impairment tests requires significant management judgments andestimates.

 

In response to the searchengine algorithm adjustment by Google in July 2007, we examined whatimpact this event might have on the recoverability of our long-lived assets inaccordance with the guidance contained in SFAS 142 and 144. As a result ofour analysis, we concluded that the carrying value of our assets has not beenimpaired. However, while we use available information to prepare our estimatesand to perform impairment evaluations, our recoverability calculations andimpairment tests require significant management judgment and estimates. Theseestimates include our projections of undiscounted cash flows and assumptionsused in calculating projected RPM, page-views, and expenses. In addition, acertain degree of judgment was exercised in determining asset groups inaccordance with generally accepted accounting principles. Had our estimates andassumptions differed, the accounting treatment might have resulted differently.Future actual results could differ significantly from the anticipated resultsas reflected in our analysis.

 

***Accounting for Stock-based Compensation***

 

We account for stock-basedawards under SFAS No. 123R which requires measurement of compensationcost for all stock-based awards at fair value on date of grant and recognitionof compensation over the service period for awards expected to vest, using themodified prospective method. The estimation of stock awards that willultimately vest requires judgment, and to the extent actual results differ fromour estimates, such amounts will be recorded as a cumulative adjustment in theperiod estimates are revised. We consider various factors when estimatingexpected forfeitures, including historical experience. Actual results maydiffer substantially from these estimates.

 

We determine the fair valueof stock options granted to employees and directors using the Black-Scholesvaluation model, which considers the exercise price relative to the marketvalue of the underlying stock, the expected stock price volatility, therisk-free interest rate and the dividend yield, and the estimated period oftime option grants will be outstanding before they are ultimately exercised.Subsequent to our IPO, through 2006, we did not have sufficient history toactually predict our volatility and therefore our assumptions about stock pricevolatility were based on the volatility rates of comparable publicly heldcompanies. These rates may or may not reflect our actual stock pricevolatility. During 2007, as we accumulated our own volatility history over longerperiods of time, our assumptions about our stock price volatility were based ona rate that was derived by taking into consideration the volatility rates ofthe aforesaid comparable publicly held companies as well as our own historicalvolatility rates. Beginning 2008, we are estimating our expected stockvolatility based solely on our own historical stock volatility rates. Had we made different assumptions about ourstock price volatility or the estimated time option and warrant grants will beoutstanding before they are ultimately exercised, the related stock based compensationexpense and our net loss and net loss per share amounts could have beensignificantly different, in the three months and nine months ended September 30,2008 and 2007.

 

***Accounting for Income Taxes***

 

As part of the process ofpreparing our consolidated financial statements, we are required to estimateour income taxes in each of the jurisdictions in which we operate. This processinvolves management estimating our actual current tax exposure together withassessing temporary differences resulting from differing treatment of items fortax and accounting purposes. These differences result in deferred tax assetsand liabilities, which are included within our consolidated balance sheet. Wemust then assess the likelihood that our deferred tax assets will be recoveredfrom future taxable income and, to the extent we believe that recovery is notmore likely than not, we must establish a valuation allowance. Significantmanagement judgment is required in determining our provision for income taxes,our deferred tax assets and liabilities and any valuation allowance recordedagainst our net deferred tax assets. We have almost fully offset ourU.S. net deferred tax asset with a valuation allowance. Our lack ofearnings history and the uncertainty surrounding our ability to generate UStaxable income prior to the expiration of such deferred tax assets were theprimary factors considered by management in establishing the valuationallowance.

 

In July 2006, FASBreleased FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes — an Interpretation of FASB Statement 109,” or FIN 48,effective for fiscal years beginning after December 15, 2006. FIN 48prescribes how a company should recognize, measure, present and disclose in itsfinancial statements uncertain tax positions that the company has taken orexpects to take on a tax return. Additionally, for tax positions to qualify fordeferred tax benefit recognition under FIN 48, the position must have atleast a “more likely than not” chance of being sustained upon challenge by therespective taxing authorities. We adopted the provisions of FIN 48 as of January 1,2007 and it has not had a material impact on our financial statements.

 

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***Redpoint Financing***

 

To account for the Redpoint Financing, we estimated the fair value ofthe three components embodied in our agreement with Redpoint:  (i) Series A Convertible PreferredStock, (ii) Series A Purchase Warrants and (iii) the Series BUnit Warrant. Further, The Series B Unit Warrant is revalued eachreporting date. We used various valuation models and techniques to determinethe individual values of the three components, including Monte Carlo andBlack-Scholes. While we believe we have applied appropriate judgment in theassumptions and estimates, variations in judgment in applying assumptions andestimates used in the valuation could have a material effect upon the valuationresults, and thus, on our financial statements.

 

TheSeries A Convertible Preferred Stock issued as part of the RedpointFinancing contains an embedded conversion option which could possibly requireseparate accounting under SFAS No. 133 — “Accounting for DerivativeInstruments and Hedging Activities”. According to paragraph 12(a) of SFAS133, in order to determine whether separate accounting is required, one has toevaluate whether the economic characteristics and risks of the conversionoption are closely related to the host contract, and the nature of the hostcontract.  We exercised judgment andevaluated this matter in accordance with EITF Topic D-109, “Determining theNature of a Host Contract Related to a Hybrid Financial Instrument Issued inthe Form of a Share under FASB Statement No.133” (Topic D-109). TopicD-109 conveys the SEC staff’s views on determining whether the characteristicsof a host contract in a hybrid financial instrument issued in the form of ashare is more akin to debt or equity. In evaluating an embedded derivativefeature for separation under SFAS 133, the consideration of the economiccharacteristics and risks of the host contract should not ignore the stated orimplied substantive terms and features of the hybrid financial instrument. Weconsidered various factors including, redemption provisions, stated rate,voting rights, whether returns are discretionary or mandatory, collateralrequirements, participation in residual earnings and liquidation preferences,in making our own determination that the host contract was more akin to equity.Had we determined that the host contract was more akin to debt and not equityit would have impacted the accounting for the host contract and the embeddedconversion option and could have had a material impact on our financialstatements.

 

**RecentlyIssued Accounting Pronouncements**

 

In March 2008, the FASB issued Statementof Financial Accounting Standards 161, “*Disclosuresabout Derivative Instruments and Hedging Activities-an amendment of FASB StatementNo. 133”* (SFAS 161). SFAS 161 gives financial statement usersbetter information about the reporting entity’s hedges by providing forqualitative disclosures about the objectives and strategies for usingderivatives, quantitative data about the fair value of and gains and losses onderivative contracts, and details of credit-risk-related contingent features intheir hedged positions. SFAS 161 is effective for financial statements issuedfor fiscal years beginning after November 15, 2008 and interim periodswithin those years. We do not expect the adoption of SFAS 161 to have amaterial effect on its financial statements.

 

On May 9, 2008, theFASB issued FASB Staff Position No. APB 14-1(FSP APB 14-1), *“Accounting for Convertible Debt Instruments That May BeSettled in Cash Upon Conversion (Including Partial Cash Settlement)”*.FSP APB 14-1 requires issuers of convertible debt that may be settled wholly orpartly in cash when converted to account for the debt and equity componentsseparately. FSP APB 14-1 is effective for fiscal years beginning after December 15,2008 and must be applied retrospectively to all periods presented. We are currently evaluating the potential impact of the adoption of FSP APB 14-1 on our consolidated financial statements.

 

**QuarterlyResults**

 

The following table setsforth our historical unaudited quarterly consolidated statement of operationsdata beginning 2007. You should read this information together with ourunaudited consolidated financial statements and the related notes appearingelsewhere in our filings. The results of historical periods are not necessarilyindicative of the results of operations for a full year or any future period.

 

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| ** **                                                                                                            | ** ** | **Quarter Ended**                                                               | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **Mar. 31,  2007**                                                              | ** ** | **Jun. 30,  2007** | ** ** | **Sep. 30,  2007** | ** ** | **Dec. 31,  2007** | ** ** | **Mar. 31,  2008** | ** ** | **Jun. 30,  2008** | ** ** | **Sep. 30,  2008** | ** ** |
| ** **                                                                                                            | ** ** | **(in thousands, except page view and RPM data)** | ** ** |
| Revenues:                                                                                                             |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Advertising revenue                                                                                                   |       | $                                                                                    | 2,884      |   | $ | 2,728 |   | $ | 2,165 |   | $ | 2,974 |   | $ | 3,013 |   | $ | 2,985 |   | $ | 3,539 |   |
| Answers services licensing                                                                                            |       | 77                                                                                   |       | 82 |   | 43 |   | 17 |   | 18 |   | 18 |   | 24 |   |
| Subscriptions                                                                                                         |       | 425                                                                                  |       | — |   | — |   | — |   | — |   | — |   | — |   |
|                                                                                                                  |       | 3,386                                                                                |       | 2,810 |   | 2,208 |   | 2,991 |   | 3,031 |   | 3,003 |   | 3,563 |   |
| Costs and expenses:                                                                                                   |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenue                                                                                                       |       | 1,144                                                                                |       | 1,320 |   | 1,179 |   | 1,247 |   | 1,393 |   | 1,416 |   | 945 |   |
| Research and development                                                                                              |       | 722                                                                                  |       | 748 |   | 769 |   | 739 |   | 875 |   | 929 |   | 866 |   |
| Sales and marketing                                                                                                   |       | 982                                                                                  |       | 1,072 |   | 1,221 |   | 676 |   | 762 |   | 933 |   | 563 |   |
| General and administrative                                                                                            |       | 926                                                                                  |       | 1,019 |   | 1,058 |   | 1,017 |   | 1,131 |   | 1,198 |   | 1,311 |   |
| Write-off of the BrainboostAnswers Engine                                                                             |       | —                                                                               |       | — |   | — |   | — |   | — |   | 3,138 |   | — |   |
| Termination fees and write-off ofcosts relating to the terminated Lexico acquisition and abandoned follow-on offering |       | —                                                                               |       | — |   | — |   | — |   | 2,543 |   | — |   | — |   |
|                                                                                                                  |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total operating expenses                                                                                              |       | 3,774                                                                                |       | 4,159 |   | 4,227 |   | 3,679 |   | 6,704 |   | 7,614 |   | 3,685 |   |
|                                                                                                                  |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating loss                                                                                                        |       | (388                                                                                 | )          | (1,349 | ) | (2,019 | ) | (688 | ) | (3,673 | ) | (4,611 | ) | (131 | ) |
| Interest income, net                                                                                                  |       | 100                                                                                  |       | 112 |   | 88 |   | 85 |   | 55 |   | 18 |   | (43 | ) |
| Other income (expense), net                                                                                           |       | (15                                                                                  | )          | 4 |   | — |   | — |   | (38 | ) | (11 | ) | 11 |   |
| Loss resulting from fair value adjustment  of warrant to purchase units of Series B preferred stock and warrants |       | —                                                                               |       | — |   | — |   | — |   | — |   | — |   | (2,056 | ) |
|                                                                                                                  |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss before income taxes                                                                                              |       | (303                                                                                 | )          | (1,233 | ) | (1,931 | ) | (603 | ) | (3,655 | ) | (4,604 | ) | (2,210 | ) |
| Income taxes                                                                                                          |       | —                                                                               |       | (14 | ) | (19 | ) | (15 | ) | (11 | ) | (15 | ) | 91 |   |
|                                                                                                                  |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                                                              |       | $                                                                                    | (303       | ) | $ | (1,247 | ) | $ | (1,950 | ) | $ | (618 | ) | $ | (3,667 | ) | $ | (4,619 | ) | $ | (2,119 | ) |
|                                                                                                                  |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Data:                                                                                                           |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Adjusted EBITDA(1)                                                                                                    |       | $                                                                                    | 160        |   | $ | (306 | ) | $ | (727 | ) | $ | 180 |   | $ | (181 | ) | $ | (670 | ) | $ | 520 |   |
| Answers.com average daily page views                                                                             |       | 4,945,000                                                                            |       | 4,441,000 |   | 3,276,000 |   | 3,447,000 |   | 3,225,000 |   | 2,641,000 |   | 2,666,000 |   |
| WikiAnswers average daily page views                                                                             |       | 293,000                                                                              |       | 440,000 |   | 639,000 |   | 1,152,000 |   | 1,885,000 |   | 2,318,000 |   | 3,094,000 |   |
| Answers.com RPM                                                                                                       |       | $                                                                                    | 6.22       |   | $ | 6.31 |   | $ | 6.17 |   | $ | 7.16 |   | $ | 6.23 |   | $ | 6.18 |   | $ | 6.44 |   |
| WikiAnswers RPM                                                                                                       |       | $                                                                                    | 4.40       |   | $ | 4.42 |   | $ | 5.17 |   | $ | 6.64 |   | $ | 6.95 |   | $ | 7.11 |   | $ | 6.89 |   |

 

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| (1)    |   | We define Adjusted EBITDA as net earnings before interest, Loss  Resulting from Fair Value Adjustment of Warrant to Purchase Units of  Series B Preferred Stock and Warrants, taxes, depreciation,  amortization, stock-based compensation, foreign currency exchange rate  differences and certain non-recurring revenues and expenses.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |   | We believe that the presentation of Adjusted EBITDA provides useful  information to investors because these measures enhance their overall  understanding of the financial performance and prospects of our ongoing  business operations. By reporting Adjusted EBITDA, we provide a basis for  comparison of our business operations between current, past and future  periods. Adjusted EBITDA is used by our management team to plan and forecast  our business because it removes the impact of our capital structure (interest  expense and Loss Resulting from Fair Value Adjustment of Series B Unit  Warrant), asset base (amortization and depreciation), stock-based  compensation expenses, taxes, foreign currency exchange rate differences and  certain non-recurring revenues and expenses from our results of operations.  More specifically, we believe that removing these impacts is important for  several reasons: |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | Adjusted EBITDA disregards amortization of intangible assets and  other specified costs resulting from acquisitions. Specifically, we exclude (a) amortization  of acquired technology from our acquisition of Brainboost Technology, LLC, or  Brainboost, developer of the Brainboost Answer Engine; (b) the Q2 2008  write-off of the Brainboost Answer Engine; (c) amortization of  intangible assets relating to our acquisition of WikiAnswers; and (d) various  costs and fees we incurred in connection with the terminated acquisition of  Lexico and the abandoned follow-on offering of securities. We believe that  excluding these expenses is helpful to investors, due to the fact that they  relate to prior acquisitions and are not necessarily indicative of future  operating expenses. While we exclude these expenses from Adjusted EBITDA we  do not exclude the revenue derived from the acquisitions. The revenue  attributable to WikiAnswers.com for the nine months ended September 30, 2008  and the years ended December 31, 2007 and 2006 was $4,645 thousand,  $1,302 thousand and $62 thousand, respectively. The revenue attributable to  our acquisition of the Brainboost technology was not quantifiable due to the  nature of its integration. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |
|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | We believe that, because of the variety of equity awards used by  companies, the varying methodologies for determining stock-based compensation  expense, and the subjective assumptions involved in those determinations,  excluding stock-based compensation from Adjusted EBITDA enhances the ability  of management and investors to compare financial results over multiple  periods. |

 

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|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                    | Prior to December 2003,  we sold lifetime subscriptions to our GuruNet service, generally for $40 per  subscription. In December 2003, we decided to alter our pricing model  and moved to an annual subscription model, for which we generally charged our  subscribers $30 per year. We have not sold subscriptions since our launch of  Answers.com in January 2005. In February 2007, we terminated the  GuruNet service and recognized $425 thousand of deferred revenue as revenue  during the quarter ended March 31, 2007. We believe that the recognition  of the $425 thousand of revenue is a one-time, non-cash event and is not  reflective of our core business and core operating results, and we have  therefore excluded this amount from Adjusted EBITDA. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | Adjusted EBITDA is not a  measure of liquidity or financial performance under generally accepted  accounting principles and should not be considered in isolation from, or as a  substitute for, a measure of financial performance prepared in accordance  with GAAP. Investors are cautioned of inherent limitations associated with  the use of Adjusted EBITDA as an analytical tool. Some of these limitations  are: |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                    | Non-GAAP financial  measures are not based on a comprehensive set of accounting rules or  principles;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                    | Many of the adjustments to  Adjusted EBITDA reflect the exclusion of items that are recurring and will be  reflected in our financial results for the foreseeable future;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                    | Other companies, including  other companies in our industry, may calculate Adjusted EBITDA differently  than us, thus limiting its usefulness as a comparative tool;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                    | Adjusted EBITDA does not  reflect the periodic costs of certain tangible and intangible assets used in  generating revenues in our business;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                    | Adjusted EBITDA does not  reflect interest income from our investments in cash and investment  securities and,                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                    | Adjusted EBITDA does not  reflect interest expense and other cost relating to financing our business,  including Loss Resulting from Fair Value Adjustment of Warrant to Purchase  Units of Series B Preferred Stock and Warrants and,                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                    | Adjusted EBITDA excludes  taxes, which is an integral cost of doing business; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | ·                                                                                                                                                                                                                                                                                                                                                                                                                    | Because Adjusted EBITDA  does not include stock-based compensation, it does not reflect the cost of  granting employees equity awards, a key factor in management’s ability to  hire and retain employees.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |

 

We compensate for these limitations byproviding specific information in the reconciliation to the GAAP amountsexcluded from Adjusted EBITDA. A reconciliation of Adjusted EBITDA to net lossis as follows: 

 

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| ** **                                                                                                             | ** ** | **Quarter Ended**  | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                             | ** ** | **Mar. 31,  2007** | ** ** | **Jun. 30,  2007** | ** ** | **Sep. 30,  2007** | ** ** | **Dec. 31,  2007** | ** ** | **Mar. 31,  2008** | ** ** | **Jun. 30,  2008** | ** ** | **Sep. 30,  2008** | ** ** |
| ** **                                                                                                             | ** ** | **(In thousands)** | ** ** |
| Net loss                                                                                                               |       | $                       | (303       | ) | $ | (1,247 | ) | $ | (1,950 | ) | $ | (618 | ) | $ | (3,667 | ) | $ | (4,619 | ) | $ | (2,119 | ) |
| Interest (income) expense, net                                                                                         |       | (100                    | )          | (112 | ) | (88 | ) | (85 | ) | (55 | ) | (18 | ) | 43 |   |
| Foreign currency exchange rate differences                                                                             |       | 15                      |       | (4 | ) | — |   | — |   | 38 |   | 11 |   | (11 | ) |
| Income taxes                                                                                                           |       | —                  |       | 14 |   | 19 |   | 15 |   | 11 |   | 15 |   | (91 | ) |
| Depreciation and amortization                                                                                          |       | 448                     |       | 444 |   | 464 |   | 442 |   | 448 |   | 383 |   | 250 |   |
| Stock-based compensation                                                                                               |       | 525                     |       | 599 |   | 574 |   | 426 |   | 501 |   | 420 |   | 392 |   |
| Write-off of the Brainboost  Answers Engine                                                                            |       | —                  |       | — |   | — |   | — |   | — |   | 3,138 |   | — |   |
| Termination fees and write-off of  costs relating to the terminatedLexico acquisition and abandoned follow-on offering |       | —                  |       | — |   | — |   | — |   | 2,543 |   | — |   | — |   |
| Loss resulting from fair value adjustment  of warrant to purchase units of Series B preferred stock and warrants  |       | —                  |       | — |   | — |   | — |   | — |   | — |   | 2,056 |   |
| Cost related to August 2007 layoffs                                                                               |       | —                  |       | — |   | 254 |   | — |   | — |   | — |   | — |   |
| Subscription revenue from lifetime subscriptions                                                                       |       | (425)                   | (1)        | — |   | — |   | — |   | — |   | — |   | — |   |
| Adjusted EBITDA                                                                                                        |       | $                       | 160        |   | $ | (306 | ) | $ | (727 | ) | $ | 180 |   | $ | (181 | ) | $ | (670 | ) | $ | 520 |   |

 

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(1)               Recognition of previously deferred revenue,following the termination of the GuruNet service in February 2007. 

 

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**ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

*Currency Risk.*Our revenue is denominated solely in U.S.dollars. Most of our expenses are also based in U.S. dollars; however, we aresubject to a significant amount of expenses that are denominated in New IsraelShekels (NIS). We expect this level of NIS expenses to continue in theforeseeable future. If the value of the U.S. dollar weakens against the valueof NIS, there will be a negative impact on our results of operations. Inaddition, to the extent we hold cash and cash equivalents that are denominatedin currencies other than the U.S. dollar; we are subject to the risk ofexchange rate fluctuations. We often hedge a portion of our foreign currencycommitments. Our derivative transactions are mainly designed to hedge shortterm cash flows related to anticipated expenses.

 

*Other Market Risk.*We invest our excess cash in highly liquidinvestments with an original maturity of three months or less.  Due to the short-term nature of theseinvestments, we believe that there is no material exposure to interest raterisk arising from our investments. Based on our investment policy, suchinstruments are highly rated by rating agencies and therefore we believe thatthere is no material exposure to the principal amount from our investments.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

Basedon an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, as amended) required byparagraph (b) of Rule 13a-15 or Rule 15d-15, as of September 30,2008, our Chief Executive Officer and Principal Financial Officer haveconcluded that our disclosure controls and procedures were effective inensuring that information required to be disclosed by us in the reports that wefile or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the Commission’s rules andforms. Our Chief Executive Officer and Principal Financial Officer alsoconcluded that, as of September 30, 2008, our disclosure controls andprocedures were effective in ensuring that information required to be disclosedby us in the reports that we file or submit under the Exchange Act isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Principal Financial Officer, to allow timely decisions regardingrequired disclosure.

 

Duringthe three months ended September 30, 2008, there were no changes in ourinternal control over financial reporting identified in connection with theevaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

We are not currently involved in any legal proceedings. However, from time to time, we may receive various legal claims incidental to our normal business activities, such as intellectual property infringement claims and claims of defamation and invasion of privacy. Although the results of claims cannot be predicted with certainty, we believe the final outcome of such matters will not have a material adverse effect on our financial position, results of operations, or cash flows.

 

**ITEM 1A. RISK FACTORS**

 

**RisksRelating to our Business**

 

***We have incurred significant andcontinuing net losses since our inception and may******continue to incur losses.***

 

Weincurred net losses of approximately $10.4 million and $4.1 millionfor the nine months ended September 30, 2008 and the year ended December 31,2007, respectively. As of September 30, 2008, we had an accumulateddeficit of approximately $69.5 million. We cannot assure you that we willbe able to achieve net income on a quarterly or annual basis. If our revenuesdo not increase, or if our expenses exceed expectations or cannot be reduced,we will continue to incur substantial losses, which would materially adverselyaffect our business and financial results.

 

***If search engines alter theiralgorithms or methods or otherwise restrict the flow of******users visiting our Web properties, our business andfinancial results could suffer.***

 

Searchengines serve as origination Web properties for users in search of information,and our Answers.com topic pages and WikiAnswers Q&A pages oftenappear as one of the top links on the pages returned by search engines,primarily Google, in response to users’ search queries. As a result, we relyheavily on search engines, primarily Google, for a substantial portion of theusers visiting our Web properties. According to our internal estimates trafficto our Web properties originating from search engines during the third quarterof 2008, excluding Google-directed definition link traffic, was approximately77% of the overall traffic to our Web properties, the majority of whichoriginated from Google and, to a much lesser but still significant extent, Yahoo!.Traffic to WikiAnswers from search engines during the same period was even moresignificant, amounting to nearly 95% of its overall traffic. If our trafficfrom search engines declines for any reason, we would suffer a significantdecline in overall traffic and revenue. For example, in July 2007, asearch engine algorithm adjustment by Google led to a drop in Google directedtraffic to Answers.com. This adjustment reduced our overall traffic byapproximately 28% based on the average traffic directed to Answers.com fromGoogle for the week prior to the adjustment as compared to the week after. As aresult, our revenue declined proportionately. In response to the Googlealgorithm adjustment, we reduced our headcount and related compensation costs,reducing our monthly base payroll expenses by approximately 12%. In September 2007,Yahoo! dropped our content from its search index, which led to a brief periodicdrop in our Yahoo! directed traffic. Search engines, at any time and for anyreason, could change their algorithms that direct search queries to our Webproperties or could restrict the flow of users visiting our Web propertiesspecifically. In fact, as illustrated above, on occasion our Web propertieshave experienced decreases in traffic, and consequently in revenue, due tothese search engine actions. We cannot guarantee that we will successfullyreact to these actions in the future and recover the lost traffic. Accordingly,a change in algorithms that search engines use to identify Web pages towardswhich traffic will ultimately be directed, or a restriction on the flow ofusers visiting our Web properties from the search engines, could cause asignificant decrease in traffic and revenues, which could adversely affect ourbusiness and financial results.

 

***If our Google Service Agreement, orGSA, is terminated by Google, we would have to seek an alternative provider of******listings and advertisements, which could adversely affectour business and financial******results. Even if renewed in January 2010, the GSA may beupdated by Google to offer terms which are less attractive, thus reducing ourrevenues potential and adversely affecting our business and financial results.***

 

Ourbusiness is dependent on the GSA, under which we obtain most of theadvertisements displayed on our Web properties and earn most of our adrevenues. The GSA is scheduled to expire on January 31, 2010, unlessrenewed upon mutual written consent. Non-renewal or renewal of the GSA byGoogle upon terms less favorable than the current terms would have an adverseaffect on our business and financial results.

 

Furthermore,Google may terminate the GSA with no advance notice if we:

 

·            takecertain prohibited actions including, among other things:

 

·                  editingor modifying the order of search results,

 

·                  redirectingend users, producing or distributing any software which prevents the display ofads by Google,

 

·                  modifying,adapting or otherwise attempting to obtain source code from Google technology,content, software and 

 

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documentation or

 

·                  engagingin any action or practice that reflects poorly on Google or otherwisedisparaging or devaluing Google’s reputation or goodwill;

 

·            breach the grant of a license to us by Google of certain trade names,trademarks, service marks, logos, domain names and other distinctive brandfeatures of Google;

 

·            breach the confidentiality provisions of the GSA;

 

·            breach the exclusivity provisions of the GSA; or

 

·            materially breach the GSA more than two times, irrespective of any cure to suchbreaches.

 

Google’stermination of the GSA would result in our need to replace this relationshipand obtain listings and advertisements from alternative providers, and we maynot succeed in obtaining ads that produce as much revenue as the Google ads,nor may we receive equally favorable terms as those provided under the GSA.Termination of the GSA and our failure to replace it on equally favorable termscould result in a material reduction in our ad revenues and could adverselyaffect our business and financial results.

 

***A downturn in the United States andglobal economic conditions could adversely affect the profitability of ourbusiness.***

 

TheU.S. and global economies are currently experiencing a significant contraction,and it is expected that we will see further economic downturn in the immediateand near future. The uncertain U.S. and global consumer spending environmentmay have a significant negative impact on the RPMs of both our Web propertiesin the fourth quarter of 2008, in 2009 and beyond. CPM rates are alreadyshowing a decline in the marketplace. While CPM-based revenue constitutes onlyapproximately 10% of our overall advertising revenue, there is uncertainty asto the impact the economic crisis will have on performance-based ads andcorresponding CPC rates. Since the vast majority of our revenue is generatedvia performance-based ads, a drop in CPC rates may result in a materialreduction in our ad revenues which would adversely affect our business andfinancial results.

 

***If in the interest of improving userexperience and user satisfaction, we decide to decrease the number of adelements displayed on our Web properties, our advertising revenues will declineand our financial results will be adversely impacted.***

 

Weclosely monitor the ratio between ad elements and actual content appearing onour Web pages. In the future we may decide that in order to enhance theuser-experience and increase user satisfaction, our pages should displayfewer ad elements. Displaying less ad-intensive Web pages is likely toresult in faster page-load and offering more content per-page is likely toappeal more to the user. A better user experience may result in more stickinesson our Web properties and a higher rate of user-retention and return visits.However, there is no assurance that reducing advertising on our Web propertieswill result in better user-retention and return visits and there can be noguarantee that the short term reduction in ad revenues will pay off in the longterm in the form of increased traffic. A decrease in the number of ad elementsdisplayed on our Web properties will result in a short-term drop in RPM and areduction in advertising revenues which will have an adverse impact on ourresults of operations.

 

***The failure of WikiAnswers to growaccording to our expectations could have an******adverse impact on our business and financial results.***

 

WikiAnswersis currently our primary growth driver and currently exceeds Answers.com inboth traffic and revenue. WikiAnswers is experiencing a growth phenomenon thatwe refer to as a “network effect”.  The site’s growth facilitates furthergrowth. As a result, we are spending increasing amounts of money anddevoting greater resources to the development of WikiAnswers. If, for whateverreason, WikiAnswers fails to perform as well as we anticipate, and the growthwe are experiencing falters or ceases, our business and financial results couldbe adversely affected.

 

***If Internet users do not interactwith our WikiAnswers Web property frequently or if******we fail to attract new users to the service, our businessand financial results will******suffer.***

 

Thesuccess of our WikiAnswers Web property is largely dependent upon usersconstantly interacting with the community by asking questions, posting answersand improving upon both. We have seen a very high correlation between growth inquestions and answers and growth in the site’s page views. We need toattract users to register as community members, visit the Web propertyfrequently and spend significant amounts of time on the Web property when theyvisit. In addition, only a very small number of users actually post informationon the site on a regular basis and are engaged in improving the information itcontains. If we are unable to encourage users to interact frequently with ourWikiAnswers Web property and to contribute content, our ability to attract newusers to the Web property, increase the number of registered users loyal to thecommunity and attract advertisers to WikiAnswers will be diminished andadversely affected. As a result, our business and financial results willsuffer, and we will not be able to grow our business as planned.

 

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***If we are unable to maintain andimprove the quality of content being contributed to******WikiAnswers, the Web property will become less valuable tothe users, less popular as******a destination for obtaining answers to questions and itsgrowth will be negatively******affected, which in turn could adversely impact our financialresults.***

 

Itis critical that we ensure that the quality of content being posted onWikiAnswers, both questions and answers, is maintained and improved over time.The better the quality of the content generated on the Web property, the morevaluable the Web property will be for users in search of answers, which in turnwill lead to stronger growth in the community size. We will need to closelymonitor the content being contributed by users and constantly be on the alertfor and filter out content that does not add value, or even worse, damages theuser experience. The increasing volume of questions asked each day and answersposted is resulting in a much more challenging environment for qualityassurance. Control of quality may also necessitate the investment of additionalresources and result in added costs. If we fail to maintain and improve thequality of the Web property’s content, the appeal of WikiAnswers to users maydiminish and the growth of the Web property may be negatively affected, whichin turn could cause our financial results to suffer. Furthermore, lower qualitycontent could also affect the way Google and other search engines rank the Webproperty and result in a drop in search-engine driven traffic which would havean adverse effect on our financial results.

 

***If we are unable to attract andretain dedicated WikiAnswers volunteer supervisors to help grow the Webproperty and encourage the community’s******expansion, our plans for growing WikiAnswers may fail andour results of operations******may be adversely affected.***

 

Muchof the monitoring of WikiAnswers content is borne by a large group of externalvolunteer supervisors, who are not employed by us. The supervisors monitorquestions and answers in specific categories in an effort to ensure questionsare being answered timely, prevent vandalism, improve consistency and encouragehigh-quality contributions. As of September 30, 2008, there were over 400such supervisors. The success of WikiAnswers is dependant, to a great extent,on the continued attention of these supervisors to WikiAnswers. If we are notable to attract and maintain enough supervisors, WikiAnswers will suffer andthe Web property will become less attractive to users, which in turn willadversely affect the site’s growth, our business and our financial results.

 

***We depend on Google to directtraffic to Answers.com through its definition link, and******the loss of this source of traffic could reduce our adrevenues and adversely affect******our business and financial results.***

 

Asmall percentage of our overall direct traffic is directed to Answers.com bythe definition link appearing on Google’s website result pages. As anadditional result of this arrangement, a significant number of secondarysearches are performed on Answers.com by users arriving via the definitionlink. We refer to the activity of these users as secondary traffic. Thedefinition link traffic is the result of a unilateral decision by Google tolink certain definitions to Answers.com, and not any contractual relationship.Google may change these links at any time, in its sole discretion. According toour internal estimates, for the third quarter of 2008, the primary andsecondary traffic from the Google definition link accounted for approximately6% of the traffic to our Web properties. If Google stops directing traffic toAnswers.com through its definition link, we would experience a reduction in ourdirect traffic and the corresponding ad revenues, which would adversely affectour business and financial results.

 

***Components of our business andoperations are experiencing rapid growth. If we fail******to effectively manage our growth, our business and operatingresults could be harmed.***

 

Wehave experienced rapid growth in our headcount and operations over the pastseveral years, which has placed, and will continue to place, significantdemands on our management, operational and financial infrastructure. If we donot effectively manage our growth, the quality of our products and servicescould suffer, which could negatively affect our brand and operating results. Toeffectively manage this growth, we will need to continue to improve ouroperational, financial and management controls and our reporting systems andprocedures. These systems enhancements and improvements will requiresignificant capital expenditures and management resources. Failure to implementthese improvements could hurt our ability to manage our growth and ourfinancial position.

 

***We have a relatively new businessmodel in an emerging******and rapidly evolvingmarket. This makes it difficult to evaluate our future prospects******and may increase therisks that we will not continue to be successful and that our******financial results could suffer.***

 

Thereare two primary categories of Internet advertising, pay-per-performance, ormost commonly cost per click, or CPC, and pay-per-impression, or cost per 1,000impressions, or CPM. In the case of performance-based advertising, theadvertiser only pays when a user clicks on an ad, as opposed to viewing the ad,as in impression-based advertising. We derive nearly all of our revenues fromonline advertising, which is an immature industry that has undergone rapid anddramatic changes in its short history. We will encounter risks and difficultiesas a growing company in a new and rapidly evolving market. We may not be ableto successfully address these risks and difficulties, which could materiallyharm our business and operating results.

 

***We may not be able to obtain capitalwhen desired on favorable terms, if at all, or******without dilution to our stockholders.***

 

Weanticipate that our current cash and cash equivalents will be sufficient tomeet our current needs for general corporate purposes for at least the next12 months. However, we may need or desire additional financing to executeon our current or future business strategies, including to:

 

·            improve traffic monetization and expand content on our Web properties;

 

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·            enhance our operating infrastructure;

 

·            acquire businesses or technologies; or

 

·            otherwise respond to competitive pressures.

 

Ifwe raise additional funds through the issuance of equity or convertible debtsecurities, the percentage ownership of our stockholders could be significantlydiluted, and these newly issued securities may have rights, preferences orprivileges senior to those of existing stockholders. We cannot assure you thatadditional financing will be available on terms favorable to us, or at all,particularly in light of the current economic downturn. If adequate funds arenot available or are not available on acceptable terms, when we desire them,our ability to invest in our operations, take advantage of unanticipatedopportunities, develop or enhance our services, or otherwise respond tocompetitive pressures would be significantly limited.

 

***New technologies could blockInternet ads, which could harm our financial results.***

 

Technologieshave been developed, and are likely to continue to be developed, that can blockthe display of Internet ads. Most of our revenues are derived from fees paid tous by advertisers in connection with the display of their ads. Ad-blockingtechnology may cause a decrease in the number of ads that we can display on ourWeb properties, which could adversely affect our ad revenues and our financialresults.

 

***We face significant competition fromsearch engines, destination portals and other******free reference and industry-specific Web properties thatcould adversely impact our******competitive position.***

 

Weface significant competition from a wide variety of Web properties, includingtraditional search engines, such as Google, Yahoo! and Ask.com, destinationportals and other free online answer engines, such as About.com,TheFreeDictionary.com, Dictionary.com and Wikipedia.org. We also compete withindustry-specific Web properties, such as Bankrate.com and WebMD.com, as wellas with other popular question and answer sites, such as Yahoo! Answers,Askville (owned by Amazon), QnA (owned by Microsoft), Yedda (owned by AOL) andAnswerbag.com (owned by Demand Media, Inc.). Many of our competitors havelonger operating histories, more extensive management experience, an employeebase with more extensive experience, better geographic coverage, largerconsumer bases, greater brand recognition and significantly greater financial,marketing and other resource than we do. We expect competition to intensify inthe future. If our competitors are more successful than we are in developingcompelling products or attracting and retaining users or advertisers, then ourcompetitive position and financial results could be adversely affected.

 

***Our failure to generate directtraffic to our Web properties could adversely affect******our business and financial results.***

 

Inaddition to search engine traffic, our traffic also originates from Internetusers arriving at our Web properties directly by typing our website addressdirectly into their Web browser, bookmarking our Web properties, using AnswerTipsand visiting sites that direct users to our Web properties. Given the wideavailability of free search engines and reference content sites, we may not beable to retain current Internet users or attract new Internet users in thisdirect fashion. If we are unable to retain our direct Internet users or attractnew direct Internet users, our ability to generate revenues would be adverselyimpacted, which could adversely affect our business and financial results.

 

***Traffic to our Web properties andadvertising demand fluctuates significantly on a******seasonal basis, which impacts our operations from quarter toquarter.***

 

Manyof our users are students that utilize our Web properties as reference sources.Our traffic fluctuates with the academic school year, rising from February throughMay, falling to its lowest levels during the summer months, rising again in September andfalling again in December through January. We expect traffic to our Webproperties to continue to fluctuate seasonally in the future. This seasonalfluctuation in traffic results in a fluctuation in our quarterly revenues,since fewer users to our Web properties translates into fewer users viewing orclicking on the advertisements on our Web properties. In addition, the demandfor our advertising inventory fluctuates during the year based on the seasonalneeds of our advertisers, rising to its highest levels during the fourthquarter and falling to its lowest levels in the first quarter. Accordingly, ourrevenue fluctuates based on the seasonality of our traffic and advertisingdemand. The effect of this seasonality makes it difficult to estimate futureoperating results based on the results of any specific quarter. As a result, wemay be unable to forecast our revenue accurately, and a failure to meet ourrevenue or expense forecasts could have an immediate and negative impact on themarket price of our common stock.

 

***Our operating results may fluctuate,which makes our results difficult to predict and******could cause our results to fall short of expectations.***

 

Ouroperating results may fluctuate as a result of a number of factors, manyoutside of our control. As a result, comparing our operating results on aperiod-to-period basis may not be meaningful, and you should not rely on ourpast results as an indication of our future performance. Our quarterly,year-to-date and annual expenses as a percentage of our revenues may differsignificantly from our historical or projected rates. Our operating results infuture quarters may fall below expectations. Any of these events could causeour stock price to fall.

 

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***Our partnerships and revenue-sharingarrangements with third-parties may not be******renewed or continued, which could impact our credibility inthe marketplace, which******could adversely affect our traffic and revenues.***

 

Wehave entered into revenue-sharing and other arrangements with third partiesthat direct traffic to our Web properties and license our online answer engineservices. Although these arrangements have not had a substantial impact on ourrevenues to date, they have provided us with third party validation of ourproduct offerings. These arrangements may be terminated or discontinued by thethird parties upon varying notice periods. Termination of any of thesearrangements could impact our credibility in the marketplace, which couldadversely affect our traffic and revenues.

 

***We may not be successful in expandingour business through acquisitions, business******combinations and other transactions, and, even if we aresuccessful, our operations******may be adversely affected as a result of these transactions.***

 

Wemay pursue acquisitions, business combinations and joint ventures, which werefer to as extraordinary transactions. Our ability to implement this businessstrategy depends in large part on our ability to compete successfully withother entities for acquisition candidates and joint venture partners. Factors affectingour ability to compete successfully include:

 

·            our financial condition and resources relative to the financial condition andresources of competitors;

 

·            our ability to issue common stock as potential consideration;

 

·            the attractiveness of our common stock as potential consideration relative tothe common stock of competitors;

 

·            our ability to obtain financing; and

 

·            our available cash, which depends upon our results of operations and our cashdemands.

 

Wemay not be able to find suitable acquisition candidates and we may not be ableto complete acquisitions on favorable terms, if at all. If we do completeacquisitions, we may not ultimately strengthen our competitive position orachieve our goals, or such acquisitions may be viewed negatively by customers,financial markets or investors. In addition, any acquisitions that we makecould lead to difficulties in integrating personnel and operations from theacquired businesses and in retaining and motivating key personnel from thesebusinesses. Acquisitions may disrupt our ongoing operations, divert managementfrom day-to-day responsibilities, increase our expenses or adversely affect ourbusiness, operating results and financial condition. For example, weexperienced such disruption, diversion and increased expenses during the courseof our failed attempt to acquire Lexico Publishing Group, LLC during the end of2007 and early in 2008. Future acquisitions may reduce our cash available foroperations and other uses and could result in an increase in amortizationexpense related to identifiable assets acquired, potentially dilutive issuancesof equity securities or the incurrence of debt, which could harm our business,financial condition and operating results.

 

***If we fail to maintain and enhance awarenessof our Web properties, our business and******financial results could be adversely affected.***

 

Webelieve that maintaining and enhancing awareness of our Web properties iscritical to achieving widespread acceptance of our services and to the successof our business. These activities may require us to spend increasing amounts ofmoney on, and devote greater resources to, advertising, marketing and otherbrand-building efforts, and these investments may not be successful. Further,even if these efforts are successful, they may not be cost-effective. If we areunable to continuously maintain and enhance our Web properties, our traffic maydecrease and we may fail to attract users and advertisers, which could in turnresult in lost revenues and adversely affect our business and financialresults.

 

***Our failure to offer compellingcontent and provide our users with quality******information could result in lost revenue, as a result of aloss of users******and advertisers.***

 

Webelieve our future success depends in part upon our ability to deliver valuablecontent through our Web properties. Answers.com is heavily dependent onlicensed content. We cannot guarantee that we will be able to enter into new orrenew current or future content agreements on commercially acceptable terms orat all. If we are unable to maintain and enhance our existing relationshipswith content providers or develop new relationships with alternative providersof content, our Answers.com service may become less attractive to Internetusers, resulting in decreased traffic to Answers.com, which could have anadverse effect on our ad revenues and a negative impact on our business.

 

***If we are unable to maintain andexpand our computer and communications systems, then******interruptions and failures in our services could result,making our services less******attractive to consumers and subjecting us to lost revenuefrom the loss of users and******advertisers.***

 

Ourability to provide high quality user experience depends on the efficient anduninterrupted operation of our computer and communications systems. Over time,our Web properties have experienced significant increases in traffic, and wecontinuously seek to further increase our user base. Accordingly, our Internetservers must accommodate spikes in demand for our Web pages in addition topotential significant growth in traffic and in data that must be stored. Delaysand interruptions could frustrate users and reduce traffic on our Webproperties, adversely affecting our operations and growth prospects.

 

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Wehave completed migration of our Answers.com and WikiAnswers Web operations intoour own collocation facility and now manage Web operations with our ownemployees. We plan to add a second collocation site in the first half of 2009in order to provide necessary redundancy of Web operations at the data centerlevel. Until such time, our operations are centered in one single data centerfacility.  If such a facility suffersinterruptions or failures in service, our Web operations would be adverselyaffected, making our services less attractive to consumers and adverselyaffecting our business and financial results.

 

Additionally,if we are unable to recruit and retain skilled employees to manage the Webhosting operations, we may not be able to properly manage the necessary tasksto keep our systems running smoothly and grow the business.

 

***If we were to lose the services ofour key personnel, we may not be able to execute******our business plan and our business could be adverselyaffected.***

 

Ourability to execute our business plan depends upon the continued service of ourexecutive officers and other key technology, marketing, community and supportpersonnel. Our employment agreements with our executive officers and keyemployees are terminable by either party upon 30-90 days notice. If welose the services of one or more of our key employees, or if one or more of ourexecutive officers or key employees joined a competitor or otherwise competedwith us, our business could be adversely affected. We cannot assure you that wewill be able to retain or replace our key personnel. If we do not succeed inretaining or replacing our key personnel, we may be unable to execute ourbusiness plan and, as a result, our business operations and financial resultsmay suffer.

 

***Our business depends on increasing use ofthe Internet by users searching for******information, advertisers marketing products and services andWeb properties seeking******to earn revenue to support their web content. If theInternet infrastructure does not******grow and is not maintained to support these activities,our business will be harmed.***

 

Oursuccess will depend on the continued growth and maintenance of the Internetinfrastructure. This includes maintenance of a reliable network backbone withthe necessary speed, data capacity and security for providing reliable Internetservices. Internet infrastructure may be unable to support the demands placedon it if the number of Internet users continues to increase, or if existing orfuture Internet users access the Internet more often or increase theirbandwidth requirements. In addition, viruses, worms and similar programs mayharm the performance of the Internet. The Internet has experienced a variety ofoutages and other delays as a result of damage to portions of itsinfrastructure, and could face outages and delays in the future. These outagesand delays could reduce the level of Internet usage as well as our ability toprovide our solutions.

 

***Rules established by theFinancial Accounting Standards Board, or FASB, require us to******expense equity compensation given to our employees and mayimpact our ability to******effectively utilize equity compensation to attract andretain employees.***

 

TheFASB has adopted changes that require companies to record a charge to earningsfor employee stock option grants and other equity incentives effective January 1,2006, which we have adopted. These accounting changes may cause us to reducethe availability and amount of equity incentives provided to employees, whichmay make it more difficult for us to attract, retain and motivate keypersonnel. Additionally, it may be difficult for us to estimate the impact ofsuch compensation charges on future operating results because they will bebased upon the fair market value of our common stock and other assumptions atfuture dates.

 

***We may be subject to liability foronline services, which may not be limited by the******safe harbors in The Digital Millennium Copyright Act, orDMCA, The Communications******Decency Act, or CDA, or the U.S. Children’s Online PrivacyProtection Act, or COPPA.******If we do not meet the safe harbor requirements, or if it isotherwise determined that******our Web properties contain actionable content, we could besubject to claims, which******could be costly and time-consuming to defend.***

 

Wehost certain services that enable individuals to generate content and engage invarious online activities. The law relating to the liability of providers ofthese online services for activities of their users is currently unsettled bothwithin the United States and internationally. Claims have been threatened andmay in the future be brought against us for defamation, invasion of privacy,negligence, copyright or trademark infringement, unlawful activity, tort,including personal injury, fraud, or other theories based on the nature andcontent of information to which we provide links, or that may be posted onlineor generated by the users of our Web properties. Our defense of any of theseactions could be costly and involve significant time and attention of ourmanagement and other resources.

 

TheDMCA is intended, among other things, to reduce the liability of online serviceproviders for listing or linking to third party Web properties that includematerials that infringe copyrights or rights of others. Additionally, portionsof the CDA are intended to provide statutory protections to online serviceproviders who distribute third party content. A safe harbor for copyrightinfringement is also available under the DMCA to certain online serviceproviders that provide specific services, if the providers take certainaffirmative steps as set forth in the DMCA. Important questions regarding thesafe harbor under the DMCA and the CDA have yet to be litigated, and we can notguarantee that we will meet the safe harbor requirements of the DMCA or of theCDA. If we are not covered by a safe harbor, for any reason, we could beexposed to claims, which could be costly and time-consuming to defend.

 

Inaddition, COPPA was enacted in October 1998. COPPA imposes civil andcriminal penalties on persons distributing material harmful to minors over theInternet to persons under the age of 17 or collecting personal information fromchildren under the age of 13. We do not knowingly collect and disclose personalinformation from minors. The manner in which COPPA may be interpreted andenforced cannot yet be 

 

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determined.Moreover, the applicability to the Internet of existing laws governing issuessuch as property ownership, copyright, defamation, obscenity and personalprivacy is uncertain. We may be subject to claims that our content violatessuch laws, which could damage our business and cause our stock price todecline.

 

Wealso periodically enter into arrangements to offer third party products,services or content under the Answers brand or through our Web properties. Wemay be subject to claims concerning these products, services or content byvirtue of our involvement in marketing, branding, broadcasting or providingaccess to them, even if we do not ourselves host, operate, provide, or provideaccess to them.

 

Itis also possible that, if any information provided directly by us containserrors or is otherwise negligently provided to users, third parties could makeclaims against us. While it is our belief that the Terms of Use governing theuse of our Web properties covers us against these types of claims, there are noassurances as to the final determination of these types of claims by any courtof law. Furthermore, investigating and defending any of these types of claims isexpensive, even to the extent that the claims are without merit or do notultimately result in liability.

 

***Third parties may claim that we areinfringing on their patents, trademarks or******copyrights, which could result in substantial costs,diversion of significant******managerial resources and significant harm to our reputation.***

 

Theindustry in which we operate is characterized by the existence of a largenumber of patents and frequent litigation based on allegations of patentinfringement. We expect that Internet technologies, software products andservices may be increasingly subject to third party patent infringement claimsas the number of competitors in our industry segment grows and thefunctionality of products in different industry segments overlaps. From time totime, third parties may assert patent infringement claims against us in variousjurisdictions that are important to our business. Additionally, third partiesmay assert trademark infringement claims with respect to brand names we usefrom time to time and content we display on our Web properties. For example, athird party may make claims against us over the display of search resultstriggered by search terms that include trademark terms. Furthermore, we may befaced with copyright infringement claims. We have received, and are likely tocontinue to receive, “cease and desist” letters demanding that we removeinfringing content from our Web properties based on a theory of copyright andtrademark infringement.

 

Asuccessful patent, trademark or copyright infringement claim against us by anythird party, could subject us to:

 

·                 substantialliability for damages and litigation costs, including attorneys’ fees;

 

·                 lawsuitsthat prevent us from further use of intellectual property and require us to permanentlycease and desist from selling or marketing products that use the intellectualproperty;

 

·                 licensingintellectual property from a third party, which could include significantlicensing and royalty fees not presently paid by us, adding materially to theour costs of operations;

 

·                 developingnew intellectual property, as a non-infringing alternative, that could delayprojects, add materially to our costs of operations and be unacceptable to ourusers, which in turn could adversely affect our traffic and revenues; and

 

·           indemnifyingthird parties who have entered into agreements with us with respect to lossesthey incurred as a result of the infringement, which could includeconsequential and incidental damages that are material in amount.

 

Regardlessof the merit of third party infringement claims, these claims could result insubstantial costs, diversion of significant resources and management attention,termination of customer contracts, loss of customers and significant harm toour reputation.

 

Finally,many of our agreements with advertisers, distribution partners, and other thirdparty partners require us to indemnify these partners for certain third partyintellectual property infringement claims, which could increase our costs as aresult of defending the claims and may require that we pay damages if therewere an adverse ruling in any of the claims. An adverse determination couldalso prevent us from offering our products and services to others and mayrequire that we procure substitute products or services, which could adverselyaffect our business and financial results.

 

***Misappropriation of our intellectualproperty could harm our reputation, adversely******affecting our competitive position and financial results.***

 

Ourability to compete depends in part upon the strength of our proprietary rightsin our technologies, brands and content. We rely on a combination ofU.S. and foreign patents, copyrights, trademark, trade secret laws andlicense agreements to establish and protect our intellectual property andproprietary rights. The efforts we have taken to protect our intellectualproperty and proprietary rights may not be sufficient or effective at stoppingunauthorized use of our intellectual property and proprietary rights. Inaddition, effective trademark, patent, copyright and trade secret protectionmay not be available or cost-effective in every country in which our servicesare made available through the Internet. There may be instances where we arenot able to fully protect or utilize our intellectual property in a manner thatmaximizes competitive advantage. If we are unable to protect our intellectualproperty and proprietary rights from unauthorized use, the value of our Webproperties may be reduced, which could negatively impact our business. Inaddition, protecting our intellectual property and other proprietary rights isexpensive and diverts critical managerial resources. If any of the foregoingwere to occur, or if we are otherwise unable to protect our 

 

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intellectual property and proprietary rights,our business and financial results could be adversely affected.

 

***New government regulation and legaluncertainties could require us to incur******significant expenses.***

 

Thelaws and regulations applicable to the Internet, and to our products andservices, are evolving and unclear and could damage our business. In addition,we will be subject to any new laws and regulations directly applicable to ourproducts and services. It is possible that laws and regulations may be adoptedcovering issues such as user privacy, pricing, taxation, content regulation,quality of products and services, and intellectual property ownership andinfringement. This legislation could expose us to substantial liability as wellas dampen the growth in use of the Internet generally, decrease the acceptanceof the Internet as a communications and commercial medium, or require us to incursignificant compliance expenses. Compliance with these laws and regulations mayalso cause us to change or limit our business practices in a manner adverse toour business.

 

Increasedregulation or the imposition of access fees could substantially increase thecosts of communicating on the Internet, potentially decreasing the demand forour products. A number of proposals have been made at the federal, state andlocal level that would impose additional taxes on the sale of goods andservices through the Internet. Such proposals, if adopted, could substantiallyimpair the growth of electronic commerce and could adversely affect us.

 

Dueto the global nature of the Internet, it is possible that the governments ofother states and foreign countries might attempt to regulate its transmissionsor prosecute us for violations of their laws. We might unintentionally violatethese laws. Such laws may be modified, or new laws may be enacted, in thefuture. Our business may be negatively affected by a variety of new or existinglaws and regulations, which may expose us to substantial compliance costs andliabilities and may impede the growth in use of the Internet generally.

 

**Risks Related to our Common Stock**

 

***Our common stock may be affected bylimited trading volume and may fluctuate******significantly.***

 

Ourcommon stock is traded on the NASDAQ Capital Market. Although an active tradingmarket has developed for our common stock, there can be no assurance that anactive trading market for our common stock will be sustained. Failure tomaintain an active trading market for our common stock may adversely affect ourshareholders’ ability to sell our common stock in short time periods, or atall. Our common stock has experienced, and may experience in the future,significant price and volume fluctuations, which could adversely affect themarket price of our common stock.

 

***We could issue additional shares of commonstock or securities convertible into or exercisable for common stock, whichmight dilute your percentage ownership interest in our company*****.**

 

Wehave authorized 100,000,000 shares of our common stock, of which approximately15,200,000 shares were issued and outstanding after giving effect to theassumed exercise of all outstanding warrants and options and assumed conversionof preferred stock as of October 30, 2008.  Our board of directorshas the authority, without action or vote of our stockholders in many cases, toissue all or a part of any authorized but unissued shares. Such stock issuancesmay be made at a price that reflects a discount from the then-current tradingprice of our common stock. In addition, in order to raise the capital that wemay need at today’s stock prices, we will need to issue securities that areconvertible into or exercisable for a significant amount of our common stock.For example, on June 16, 2008, we sold Series A Convertible PreferredStock and related warrants for $6.0 million in the Redpoint Financing. These issuances may dilute your percentage ownership interest, which will havethe effect of reducing your influence on matters on which our stockholdersvote. You may incur additional dilution if holders of stock options, whethercurrently outstanding or subsequently granted, exercise their options or ifwarrant holders exercise their warrants to purchase shares of our commonstock.  In addition, these issuances, or the perception that suchissuances may occur in the future, may have a depressant effect on our stockprice and make it more difficult to raise capital in the future on reasonableterms or at all.

 

***There may be substantial sales ofour common stock, which could cause our stock price******to fall.***

 

Allof our issued and outstanding shares are immediately available for sale in thepublic market without registration under Rule 144. Sales of a substantialnumber of shares of our common stock could cause the price of our securities tofall and could impair our ability to raise capital by selling additionalsecurities.

 

***We do not intend to pay dividends onour common stock.***

 

Wehave never declared or paid any cash dividend on our common stock. We currentlyintend to retain any future earnings and do not expect to pay any dividends onour common stock in the foreseeable future.

 

***We may incur penalties if theregistration statement covering the common stock underlying the Series AConvertible Preferred Stock and the Common Stock Purchase Warrants does notremain effective.***

 

Under the terms of the registration rights agreementwe entered into with the holders of our Series A Convertible PreferredStock, we are 

 

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obligated to register the common stockunderlying the Series A Convertible Preferred Stock and the Common StockPurchase Warrants. The registration rights carry penalties in the event we donot meet these registration obligations. The registration statement registeringthe common stock underlying the Series A Convertible Preferred Stock andthe Common Stock Purchase Warrants was declared effective by the Securities andExchange Commission on September 16, 2008. We agreed to use ourcommercially reasonable best efforts to ensure the continued effectiveness ofthe registration statement thereafter. In the event sales of any or all of thesecurities covered by the registration statement cannot be made, whetherbecause of our failure to keep the registration statement effective, or forvarious other reasons, then we must pay liquidated damages in cash to theholders of our Series A Convertible Preferred Stock in the amount of 1.0%per month, on a daily pro rata basis, up to a maximum of 8.0%, of the aggregatepurchase price.

 

***We have issued and could issueadditional “blank check” preferred stock without stockholder approval with the******effect of diluting then current stockholder interests.***

 

Ourcertificate of incorporation authorizes the issuance of up to1,000,000 shares of “blank check” preferred stock with designations,rights and preferences as may be determined from time to time by our board ofdirectors. Accordingly, our board of directors is empowered, withoutstockholder approval, to issue a series of preferred stock with dividend,liquidation, conversion, voting or other rights, which could dilute theinterest of, or impair the voting power of, our stockholders. The issuance of aseries of preferred stock could be used as a method of discouraging, delayingor preventing a change in control. On June 16, 2008 as part of theRedpoint Financing, we issued 60,000 shares of Series A ConvertiblePreferred Stock.  In the event the UnitWarrant is exercised we will issue shares of Series B ConvertiblePreferred Stock.

 

***The holders of our Series A ConvertiblePreferred Stock are entitled to receive liquidation payments in preference tothe holders of our common stock.***

 

Asof July 30, 2008, 60,000 shares of our Series A Convertible PreferredStock were outstanding. Pursuant to the terms of the certificate of designationcreating the Series A Convertible Preferred Stock, upon a liquidation ofour company, the holders of shares of the Series A Convertible PreferredStock are entitled to receive a liquidation payment prior to the payment of anyamount with respect to the shares of our common stock. The amount of thispreferential liquidation payment is equal to the greater of (i) $100 pershare of Series A Convertible Preferred Stock, plus the amount of anyaccrued but unpaid dividends on those shares and any other fees or liquidateddamages owing thereon or (ii) such amount per share as would have beenpayable had all shares of Series A Convertible Preferred Stock been uponany such liquidation converted to common stock immediately prior to suchliquidation.  Dividends accrue on the shares of Series A ConvertiblePreferred Stock at a rate of 6% per annum. In addition, in the event the Unit Warrant is exercised we will issue upto 70,000 shares of Series B Convertible Preferred Stock.  If issued, the Series B ConvertiblePreferred Stock would have pari passu rights with the Series A ConvertiblePreferred Stock upon a liquidation of our company to receive a liquidationpayment prior to the payment of any amount with respect to the shares of ourcommon stock on substantially similar terms as the Series A ConvertiblePreferred Stock.

 

***Provisions in our charter documentsand under Delaware law could discourage a******takeover that stockholders may consider favorable.***

 

Provisionsof our Amended and Restated Certificate of Incorporation and Bylaws could makeit more difficult for a third party to acquire us, even if doing so would bebeneficial to our stockholders. For example, our board of directors is dividedinto three classes, with one class being elected each year by our stockholders,which generally makes it more difficult for stockholders to replace a majorityof directors and obtain control of our board. In addition, stockholder meetingsmay be called only by our board of directors, the chairman of the board and thepresident, advance notice is required prior to stockholder proposals andstockholders may not act by written consent. Furthermore, we have authorizedpreferred stock that is undesignated, making it possible for our board ofdirectors to issue preferred stock with voting or other rights or preferencesthat could impede the success of any attempt to change control of our company.

 

Delawarelaw also could make it more difficult for a third party to acquire us.Specifically, Section 203 of the Delaware General Corporation Law, towhich our company is subject, may have an anti-takeover effect with respect totransactions not approved in advance by our board of directors, includingdiscouraging attempts that might result in a premium over the market price forthe shares of common stock held by our stockholders.

 

***We are at risk of securities classaction litigation.***

 

Securitiesclass action litigation has often been brought against a company following adecline in the market price of its securities. This risk is especially relevantfor us because Internet companies often experience significant stock pricevolatility. If we faced such litigation, it could result in substantial costsand diversion of management’s attention and resources, which could adverselyaffect our business.

 

***We determinedthat we had material weaknesses in our internal control over financialreporting. As a result, current and potential stockholders could loseconfidence in our financial reporting which could harm our business and tradingprice of our stock.***

 

Section 404of the Sarbanes-Oxley Act of 2002 and the related rules and regulations ofthe SEC require annual management assessments of the effectiveness of ourinternal control over financial reporting and a report by our independentregistered public accounting firm attesting to and reporting on these controls.We dedicated significant amounts of time and resources to ensure compliancewith this legislation for the year ended December 31, 2007. Based on theirevaluation, our principal executive and principal financial officers concludedthat, as of December 31, 2007, our disclosure controls and procedures werenot effective due to the material weaknesses in our internal controls over 

 

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(i) access to, and changes in, ourinformation technology financial applications and underlying financial data;and (ii) the authority of our officers to obligate the Company. Because ofthese material weaknesses, our management concluded that, as of December 31,2007, we did not maintain effective internal control over financial reportingbased on the criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO). Additionally, our auditors issued an adverse opinion with respect tothe effectiveness of our internal controls over financial reporting as of December31, 2007.  As a result, current andpotential stockholders could lose confidence in our financial reporting whichcould harm our business and trading price of our common stock.

 

***Material weaknesses in our internalcontrols may impede our ability to******produce timelyand accurate financial statements, which could cause us to fail to******file our periodicreports timely, result in inaccurate financial reporting or******restatements of our financialstatements, subject our stock to delisting and******materially harm our businessreputation and stock price.***

 

Asa public company, we are required to file annual and quarterly periodic reportscontaining our financial statements with the Securities and Exchange Commissionwithin prescribed time periods. As part of The NASDAQ Capital Market listingrequirements, we are also required to provide our periodic reports, or makethem available, to our stockholders within prescribed time periods. If we orour auditors were to determine that our internal controls over financialreporting suffer material weaknesses, we may not be able to produce accuratefinancial statements, which could cause restatements of, or result in delays inproducing, our financial statements. If we are required to restate ourfinancial statements in the future, any specific adjustment may be adverse andmay cause our operating results and financial condition, as restated, on anoverall basis to be materially and adversely impacted. As a result, we ormembers of our management could be the subject of adverse publicity,investigations and sanctions by such regulatory authorities as the Securitiesand Exchange Commission and subject to shareholder lawsuits. Any of the aboveconsequences could cause our stock price to decline materially and could imposesignificant unanticipated costs on us.

 

Ifwe are not able to issue our financial statements in a timely manner, we willnot be able to comply with the periodic reporting requirements of theSecurities and Exchange Commission and the listing requirements of The NASDAQCapital Market. If these events occur, our common stock listing on The NASDAQCapital Market could be suspended or terminated and our stock price couldmaterially suffer. In addition, we or members of our management could besubject to investigation and sanction by the Securities and Exchange Commissionand other regulatory authorities and to shareholder lawsuits, which couldimpose significant additional costs on us, divert management attention andmaterially harm our operating results, financial condition, business reputationand stock price.

 

**Risks Related to our Location in Israel**

 

***Conditions in Israel may limit ourability to produce and sell our product, which******would lead to a decrease in revenues.***

 

Becausemost of our operations are conducted in Israel, our operations are directlyaffected by economic, political and military conditions affecting Israel.Specifically, we could be adversely affected by:

 

·                 anymajor hostilities involving Israel;

 

·                 afull or partial mobilization of the reserve forces of the Israeli army;

 

·                 theinterruption or curtailment of trade between Israel and its present tradingpartners;

 

·                 risksassociated with the fact that a certain number of our key employees reside inwhat are commonly referred to as occupied territories;

 

·                 risksassociated with outages and disruptions of communications networks due to anyhostilities involving Israel; and

 

·                 asignificant downturn in the economic or financial conditions in Israel.

 

Sincethe establishment of the State of Israel in 1948, a number of armed conflictshave taken place between Israel and its Arab neighbors and a state ofhostility, varying in degree and intensity, has led to security and economicproblems for Israel. Despite negotiations to effect peace between Israel andits Arab neighbors, the future of these peace efforts is uncertain. Since October 2000,there has been a significant increase in violence, civil unrest and hostility,including armed clashes between the State of Israel and the Palestinians, andacts of terror have been committed inside Israel and against Israeli targets inthe West Bank and Gaza Strip. In addition, the armed conflict with Hezbollah onthe northern border of Israel during the summer of 2006, negatively affectedbusiness conditions in Israel. There is no indication as to how longhostilities will last or whether there will be any further escalation. Anyfurther escalation in these hostilities or any future conflict, politicalinstability or violence in the region may have a negative effect on ourbusiness, harm our results of operations and adversely affect our share price.

 

Furthermore,there are a number of countries that restrict business with Israel or withIsraeli companies, which may limit our ability to promote our products andservices those countries.

 

***We may not be able to enforcecovenants not-to-compete under current Israeli law that******might result in added competition for our products.***

 

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Wehave non-competition agreements with all of our employees, almost all of whichare governed by Israeli law. These agreements prohibit our employees fromcompeting with or working for our competitors, generally during and for up to12 months after termination of their employment. However, Israeli courtsare reluctant to enforce non-compete undertakings of former employees and tend,if at all, to enforce those provisions for relatively brief periods of time inrestricted geographical areas and only when the employee has obtained uniquevalue to the employer specific to that employer’s business and not justregarding the professional development of the employee. If we are not able toenforce non-compete covenants, we may be faced with added competition.

 

***The Israeli government tax benefitsprogram in which we currently participate and******from which we receive benefits requires us to meet severalconditions. These programs******or benefits may be terminated or reduced in the future,which may result in an******increase in our tax liability.***

 

OurIsraeli subsidiary receives tax benefits authorized under Israeli law forcapital investments that are designated as “Approved Enterprises.” To beeligible for these tax benefits, we must meet certain conditions. If we fail tomeet such conditions, these tax benefits could be cancelled, and we could berequired to pay increased taxes or refund the amount of tax benefits wereceived, together with interest and penalties. Israeli governmentalauthorities have indicated that the government may in the future reduce oreliminate the benefits of such programs. The termination or reduction of theseprograms and tax benefits could increase our Israeli tax rates, and therebyreduce our net profits or increase our net losses.

 

***U.S. and Israeli tax authorities mayinterpret tax issues in manners other than those******which we have adopted, which may expose us to taxliabilities.***

 

Weoperate in the U.S. and in Israel and our earnings are subject to taxationin both jurisdictions, at different rates. Relevant tax authorities maydisagree with our interpretation and application in practice of tax laws andmay dispute various assumptions we make during our tax planning process.Further, the tax authorities in the U.S. and/or Israel may take exceptionwith the transfer price of transactions between Answers Corporation and itswholly owned Israeli subsidiary. If there is a successful tax challenge of ourtax position, our interpretation and/or application of tax laws in practice, wemay be forced to recognize additional tax liabilities, which may include interestand penalties. This may harm our results of operations and adversely affect ourfinancial condition. Our unrecognized tax benefits disclosed in the notes toour financial statements include amounts relating to this risk factor.

 

***Our business may be impacted by NISexchange rate fluctuations, which may negatively******affect our earnings.***

 

Exchangerate fluctuations between the U.S. dollar and the NIS may negativelyaffect our earnings. Our revenues and most of our expenses are denominated inU.S. dollars. However, a very significant portion of the expensesassociated with our Israeli operations, including personnel and facilitiesrelated expenses, are incurred in NIS. Consequently, a devaluation of theU.S. dollar in comparison to the NIS will have the effect of increasingthe dollar cost of our operations in Israel. In 2006, 2007, and the first ninemonths of 2008, the U.S. dollar depreciated against the NIS by 8.2%, 9.0%,and 11%, respectively. We cannot predict any future trends in the rate ofdevaluation or appreciation of the NIS against the U.S. dollar or of theU.S. dollar against the NIS. Despite the fact that we often use varioushedging tools, including forward contracts and options, to minimize the effectof currency fluctuations on our income, if the U.S. dollar cost of ouroperations in Israel increases, our dollar-measured consolidated results ofoperations will be adversely affected.

 

**ITEM 2.****                                                    ****UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

N/A

 

**ITEM 3.****                                                    ****DEFAULTS UPON SENIORSECURITIES**

 

N/A

 

**ITEM 4.****                                                    ****SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Atour Annual Meeting of Stockholders held on September 9, 2008, thefollowing actions were taken:

 

The following Directors wereelected for terms of office expiring in 2011:

 
| ** **         | ** ** | **VOTES FOR** | ** ** | **VOTES WITHHELD** | ** ** |
|--------------------|------------|--------------------|------------|-------------------------|------------|
|               |       |               |       |                    |       |
| Mark A. Tebbe      |       | 6,686,030          |       | 1,174,752               |       |
|               |       |               |       |                    |       |
| Lawrence S. Kramer |       | 6,703,526          |       | 1,157,265               |       |

 

Aproposal to amend our Amended and Restated Certificate of Incorporation toincrease the authorized common stock from 30,000,000 shares to 100,000,000shares was approved. The stockholders cast 7,068,861 votes in favor of thisproposal and 750,225 votes against. There 

 

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were 41,705 abstentions.

 

Aproposal to amend our 2005 Incentive Compensation Plan to increase thenumber of shares available for grant under such plan from 1,100,000 shares to1,350,000 shares was approved.The stockholders cast 3,082,454 votes in favor of this proposal and 360,052votes against. There were 696,629 abstentions.

 

Aproposal to approve the potential issuance of shares of common stockequal to 20% or more of our outstanding common stock upon conversion or exercise of thesecurities issued in, or issuable pursuant to, our June 16, 2008 privateplacement of securities or the payment of dividends in shares of common stockon such securities, was approved. Thestockholders cast 3,954,132 votes in favor of this proposal and 153,533 votesagainst. There were 31,470 abstentions.

 

Aproposal to ratify the appointment by our Audit Committee of SomekhChaikin, a member of KPMG International, to serve as independent registeredpublic accounting firm for us for the fiscal year ending December 31,2008, was approved. Thestockholders cast 7,480,334 votes in favor of this proposal and 231,458 votesagainst. There were 148,999 abstentions.

 
| **ITEM 5.** | **OTHER  INFORMATION** |
|-------------|------------------------|
|        |                   |
| N/A         |                   |
|        |                   |
| **ITEM 6.** | **EXHIBITS**           |
| ** **  | ** **             |
|        | 31.1                   | Certification of Chief Executive Officer required under  Rule 13a-14(a)/15d-14(a) under the Exchange Act. |   |
|        |                   |   |   |
|        | 31.2                   | Certification of Principal Financial Officer required under  Rule 13a-14(a)/15d-14(a) under the Exchange Act. |   |
|        |                   |   |   |
|        | 32.1                   | Certification of Chief Executive Officer pursuant to 18 U.S.C  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |   |
|        |                   |   |   |
|        | 32.2                   | Certification of Principal Financial Officer pursuant to 18 U.S.C  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |   |

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

 
|                         | **ANSWERS  CORPORATION** |
|------------------------------|--------------------------|
|                         | (Registrant)             |
|                         |                     |
|                         |                     |
| Date: November 6,  2008 | By:                      | /s/ Robert S. Rosenschein |
|                         |                     |   |
|                         |                     | Robert S. Rosenschein |
|                         |                     | Chief Executive Officer |
|                         |                     |
|                         |                     |
| Date: November 6, 2008       | By:                      | /s/ Steven Steinberg |
|                         |                     |   |
|                         |                     | Steven Steinberg |
|                         |                     | Chief Financial Officer |
|                         |                     | (Principal Financial  Officer) |

 

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