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** **

 

** **

**UNITEDSTATES 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: JUNE 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’stelephone number)

 

 

(FormerName, Former Address and Former Fiscal Year, if changed since last report)

 

Indicate by check markwhether the 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):

 

 Large accelerated 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 7,859,890 as of July 30, 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 June 30, 2008 and December 31, 2007                       | 4 |
|                                          |                                                                                                   |   |
|                                          | Consolidated  Statements of Operations for the three and six months ended June 30,  2008 and 2007 | 5 |
|                                          |                                                                                                   |   |
|                                          | Consolidated  Statements of Cash Flows for the six months ended June 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            | 19 |
|                                          |                                                                                                   |   |
| Item  3.                                      | Quantitative  and Qualitative Disclosures About Market Risk                                            | 35 |
|                                          |                                                                                                   |   |
| Item  4.                                      | Controls  and Procedures                                                                               | 35 |
| ** **                                    | ** **                                                                                             | ** ** |
| **PART II — OTHER  INFORMATION**    |                                                                                                   |
|                                          |                                                                                                   |   |
| Item 1.                                       | Legal  Proceedings                                                                                     | 36 |
|                                          |                                                                                                   |   |
| Item 1A.                                      | Risk Factors                                                                                           | 36 |
|                                          |                                                                                                   |   |
| Item 2.                                       | Unregistered Sales of  Equity Securities and Use of Proceeds                                           | 46 |
|                                          |                                                                                                   |   |
| Item 3.                                       | Defaults Upon Senior  Securities                                                                       | 46 |
|                                          |                                                                                                   |   |
| Item 4.                                       | Submission of Matters to a  Vote of Security Holders                                                   | 46 |
|                                          |                                                                                                   |   |
| Item 5.                                       | Other Information                                                                                      | 47 |
|                                          |                                                                                                   |   |
| Item 6.                                       | Exhibits                                                                                               | 47 |
|                                          |                                                                                                   |   |
| 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 andSubsidiary

 

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

 
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **June 30** | ** ** | **December 31** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **2008**         | ** ** | **2007**             | ** ** |
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **$**            | ** ** | **$**                | ** ** |
| **Assets**                                                                                                                                                                                                                                                                                             |       |             | ** ** |                 |       |
|                                                                                                                                                                                                                                                                                                   |       |             | ** ** |                 |       |
| **Current assets:**                                                                                                                                                                                                                                                                                    |       |             | ** ** |                 |       |
| Cash and  cash equivalents                                                                                                                                                                                                                                                                             | ** ** | **10,187**       | ** ** | 6,778                |       |
| Investment  securities                                                                                                                                                                                                                                                                                 | ** ** | **—**       | ** ** | 700                  |       |
| Accounts  receivable                                                                                                                                                                                                                                                                                   | ** ** | **1,199**        | ** ** | 1,448                |       |
| Prepaid  expenses and other current assets                                                                                                                                                                                                                                                             | ** ** | **946**          | ** ** | 487                  |       |
| **Total current assets**                                                                                                                                                                                                                                                                               | ** ** | **12,332**       | ** ** | 9,413                |       |
|                                                                                                                                                                                                                                                                                                   |       |             | ** ** |                 |       |
| **Long-term deposits (restricted)**                                                                                                                                                                                                                                                                    | ** ** | **285**          | ** ** | 196                  |       |
|                                                                                                                                                                                                                                                                                                   |       |             | ** ** |                 |       |
| **Deposits in respect of employee severance obligations**                                                                                                                                                                                                                                              | ** ** | **1,524**        | ** ** | 1,232                |       |
|                                                                                                                                                                                                                                                                                                   |       |             | ** ** |                 |       |
| **Property and equipment,** net  of $1,748 and $1,615 accumulated depreciation as of June 30, 2008 and  December 31, 2007, respectively                                                                                                                                                      | ** ** | **1,224**        | ** ** | 1,012                |       |
|                                                                                                                                                                                                                                                                                                   |       |             | ** ** |                 |       |
| **Other assets:**                                                                                                                                                                                                                                                                                      |       |             | ** ** |                 |       |
| Intangible  assets, net of $639 and $2,352 accumulated amortization as of June 30,  2008and December 31, 2007, respectively                                                                                                                                                                  | ** ** | **1,124**        | ** ** | 4,766                |       |
| Goodwill                                                                                                                                                                                                                                                                                               | ** ** | **437**          | ** ** | 437                  |       |
| Prepaid  expenses, long-term, and other assets                                                                                                                                                                                                                                                         | ** ** | **189**          | ** ** | 275                  |       |
| Deferred  charges (Lexico acquisition and public offering)                                                                                                                                                                                                                                             | ** ** | **—**       | ** ** | 1,267                |       |
| **Total other assets**                                                                                                                                                                                                                                                                                 | ** ** | **1,750**        | ** ** | 6,745                |       |
|                                                                                                                                                                                                                                                                                                   |       |             | ** ** |                 |       |
| **Total assets**                                                                                                                                                                                                                                                                                       | ** ** | **17,115**       | ** ** | 18,598               |       |
|                                                                                                                                                                                                                                                                                                   |       |             | ** ** |                 |       |
| **Liabilities and stockholders’ equity**                                                                                                                                                                                                                                                          |       |             | ** ** |                 |       |
|                                                                                                                                                                                                                                                                                                   |       |             | ** ** |                 |       |
| **Current liabilities:**                                                                                                                                                                                                                                                                               |       |             | ** ** |                 |       |
| Accounts  payable                                                                                                                                                                                                                                                                                      | ** ** | **461**          | ** ** | 968                  |       |
| Accrued  expenses                                                                                                                                                                                                                                                                                      | ** ** | **795**          | ** ** | 1,045                |       |
| Accrued  compensation                                                                                                                                                                                                                                                                                  | ** ** | **812**          | ** ** | 551                  |       |
| Warrant to  purchase units of Series B preferred stock and warrants                                                                                                                                                                                                                               | ** ** | **3,511**        | ** ** | **—**           | ** ** |
| Capital  lease obligation – current portion                                                                                                                                                                                                                                                       | ** ** | **76**           | ** ** | **—**           | ** ** |
| Deferred  revenues                                                                                                                                                                                                                                                                                     | ** ** | **4**            | ** ** | 16                   |       |
| **Total current liabilities**                                                                                                                                                                                                                                                                          | ** ** | **5,659**        | ** ** | 2,580                |       |
|                                                                                                                                                                                                                                                                                                   |       |             | ** ** |                 |       |
| **Long-term liabilities:**                                                                                                                                                                                                                                                                             |       |             | ** ** |                 |       |
| Liability in  respect of employee severance obligations                                                                                                                                                                                                                                                | ** ** | **1,647**        | ** ** | 1,233                |       |
| Capital  lease obligation, net of current portion                                                                                                                                                                                                                                                      | ** ** | **152**          | ** ** | **—**           | ** ** |
| Deferred tax  liability                                                                                                                                                                                                                                                                                | ** ** | **20**           | ** ** | 14                   |       |
| **Total long-term liabilities**                                                                                                                                                                                                                                                                        | ** ** | **1,819**        | ** ** | 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 shares authorized, 60,000 and 0 shares issued and outstanding as of June 30, 2008 and  December 31, 2007, respectively | ** ** | **55**           | ** ** | **—**           | ** ** |
|                                                                                                                                                                                                                                                                                                   |       |             | ** ** |                 |       |
| **Stockholders’ equity:**                                                                                                                                                                                                                                                                         |       |             | ** ** |                 |       |
| Preferred  stock: $0.01 par value; 940,000 shares authorized, none issued                                                                                                                                                                                                                              |       | —           | ** ** | —               |       |
| Common  stock; $0.001 par value; 30,000,000 shares authorized; 7,859,890 sharesissued and  outstanding as of June 30, 2008 and December 31, 2007                                                                                                                                             | ** ** | **8**            | ** ** | 8                    |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                                            | ** ** | **76,989**       | ** ** | 73,893               |       |
| Accumulated  other comprehensive loss                                                                                                                                                                                                                                                                  | ** ** | **(27**          | **)**      | (28                  | )          |
| Accumulated  deficit                                                                                                                                                                                                                                                                                   | ** ** | **(67,388**      | **)**      | (59,102              | )          |
| **Total stockholders’ equity**                                                                                                                                                                                                                                                                    | ** ** | **9,582**        | ** ** | 14,771               |       |
| ** **                                                                                                                                                                                                                                                                                             | ** ** | ** **       | ** ** |                 |       |
| **Total liabilities and stockholders’ equity**                                                                                                                                                                                                                                                    | ** ** | **17,115**       | ** ** | 18,598               |       |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**ConsolidatedStatements of Operations (unaudited, in thousands except share and per sharedata)**

 
| ** **                                                                                                              | ** ** | **Three months ended June 30** |       | **Six months ended June 30** |   |
|-------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|--------|
| ** **                                                                                                              | ** ** | **2008**                                           | ** ** | **2007**                                         |   | **2008** | ** ** | **2007** |   |
| ** **                                                                                                              | ** ** | **$**                                              | ** ** | **$**                                            |   | **$** | ** ** | **$** |   |
|                                                                                                                    |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| **Revenues:**                                                                                                           |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| Advertising  revenue                                                                                                    | ** ** | **2,985**                                          | ** ** | 2,728                                            |   | **5,998** | ** ** | 5,612 |   |
| Answers  service licensing                                                                                              | ** ** | **18**                                             | ** ** | 82                                               |   | **36** | ** ** | 159 |   |
| Subscriptions                                                                                                           | ** ** | **—**                                         | ** ** | —                                           |   | **—** | ** ** | 425 |   |
| ** **                                                                                                              |       | **3,003**                                          | ** ** | 2,810                                            |   | **6,034** | ** ** | 6,196 |   |
|                                                                                                                    |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| **Costs and expenses:**                                                                                                 |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| Cost of  revenue                                                                                                        | ** ** | **1,416**                                          | ** ** | 1,320                                            |   | **2,809** | ** ** | 2,464 |   |
| Research and  development                                                                                               | ** ** | **929**                                            | ** ** | 748                                              |   | **1,804** | ** ** | 1,469 |   |
| Sales and  marketing                                                                                                    | ** ** | **933**                                            | ** ** | 1,072                                            |   | **1,695** | ** ** | 2,054 |   |
| General and  administrative                                                                                             | ** ** | **1,198**                                          | ** ** | 1,019                                            |   | **2,329** | ** ** | 1,945 |   |
| Write-off of  the Brainboost Answer Engine                                                                              | ** ** | **3,138**                                          | ** ** | —                                           |   | **3,138** | ** ** | — |   |
| Termination  fees and write-off of costs relating tothe terminated Lexico  acquisition and abandoned follow-on offering |       | —                                             | ** ** | —                                           |   | **2,543** | ** ** | — |   |
| **Total operating expenses**                                                                                            | ** ** | **7,614**                                          | ** ** | 4,159                                            |   | **14,318** | ** ** | 7,932 |   |
|                                                                                                                    |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| **Operating loss**                                                                                                      | ** ** | **(4,611**                                         | **)**      | (1,349                                           | )      | **(8,284** | **)** | (1,736 | ) |
|                                                                                                                    |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| Interest  income, net                                                                                                   | ** ** | **18**                                             | ** ** | 112                                              |   | **73** | ** ** | 212 |   |
| Other income  (expense), net                                                                                            | ** ** | **(11**                                            | **)**      | 4                                                |   | **(49** | **)** | (12 | ) |
|                                                                                                                    |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| **Loss before income taxes**                                                                                            | ** ** | **(4,604**                                         | **)**      | (1,233                                           | )      | **(8,260** | **)** | (1,536 | ) |
|                                                                                                                    |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| Income tax  expense                                                                                                     | ** ** | **(15**                                            | **)**      | (14                                              | )      | **(26** | **)** | (14 | ) |
|                                                                                                                    |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| **Net loss**                                                                                                            | ** ** | **(4,619**                                         | **)**      | (1,247                                           | )      | **(8,286** | **)** | (1,550 | ) |
|                                                                                                                    |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| **Basic and diluted net loss per common share**                                                                         | ** ** | **(0.59**                                          | **)**      | (0.16                                            | )      | **(1.06** | **)** | (0.20 | ) |
|                                                                                                                    |       |                                               | ** ** |                                             |   |   | ** ** |   |   |
| **Weighted average shares used in computing basic and****diluted  net loss per common share**                           | ** ** | **7,859,890**                                      | ** ** | 7,853,818                                        |   | **7,859,890** | ** ** | 7,840,140 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**ConsolidatedStatements of Cash Flows****(unaudited, in thousands)**

 
| ** **                                                                                                                  | ** ** | **Six months ended June 30** |       |
|-----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2008**                                         | ** ** | **2007** |   |
| ** **                                                                                                                  | ** ** | **$**                                            | ** ** | **$** |   |
| **Cash flows from operating activities:**                                                                                   |       |                                             | ** ** |   |   |
| **Net loss**                                                                                                                | ** ** | **(8,286**                                       | **)**      | (1,550 | ) |
| **Adjustments to reconcile net loss to net cash used in operating  activities:**                                            |       |                                             | ** ** |   |   |
| Depreciation  and amortization                                                                                              | ** ** | **831**                                          | ** ** | 892 |   |
| Deposits in  respect of employee severance obligations                                                                      | ** ** | **(292**                                         | **)**      | (119 | ) |
| Increase in  liability in respect of employee severance obligations                                                         | ** ** | **402**                                          | ** ** | 214 |   |
| Stock-based  compensation to employees and directors                                                                        | ** ** | **921**                                          | ** ** | 1,123 |   |
| 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**                                          | ** ** | — |   |
| Loss on  disposal of property and equipment                                                                                 | ** ** | **3**                                            | ** ** | — |   |
| Decrease in  deferred tax asset                                                                                             | ** ** | **6**                                            | ** ** | 14 |   |
| Gains from  exchange rates forward contracts, net                                                                           | ** ** | **(90**                                          | **)**      | — |   |
| Exchange  rate losses                                                                                                       | ** ** | **49**                                           | ** ** | 12 |   |
| **Changes in operating assets and liabilities:**                                                                            |       |                                             | ** ** |   |   |
| Decrease in  accounts receivable and other current assets                                                                   | ** ** | **160**                                          | ** ** | 24 |   |
| Decrease  (increase) in prepaid expenses and other assets                                                                   | ** ** | **86**                                           | ** ** | (92 | ) |
| Decrease in  accounts payable                                                                                               | ** ** | **(161**                                         | **)**      | (49 | ) |
| Increase  (decrease) in accrued expenses and other current liabilities                                                      | ** ** | **247**                                          | ** ** | (20 | ) |
| Decrease in  deferred revenues                                                                                              | ** ** | **(12**                                          | **)**      | (457 | ) |
| **Net cash used in operating activities**                                                                                   | ** ** | **(2,335**                                       | **)**      | (8 | ) |
|                                                                                                                        |       |                                             | ** ** |   |   |
| **Cash flows from investing activities:**                                                                                   |       |                                             | ** ** |   |   |
| Capital  expenditures                                                                                                       | ** ** | **(303**                                         | **)**      | (448 | ) |
| Increase in  long-term deposits                                                                                             | ** ** | **(89**                                          | **)**      | (100 | ) |
| Deferred  charges relating to planned acquisition                                                                           |       | —                                           | ** ** | (114 | ) |
| Purchases of  investment securities                                                                                         | ** ** | **—**                                       | ** ** | (3,205 | ) |
| Proceeds  from sales of investment securities                                                                               | ** ** | **700**                                          | ** ** | 3,321 |   |
| **Net cash provided by (used in) investing activities**                                                                     | ** ** | **308**                                          | ** ** | (546 | ) |
|                                                                                                                        |       |                                             | ** ** |   |   |
| **Cash flows from financing activities:**                                                                                   |       |                                             | ** ** |   |   |
| Exercise of  common stock options                                                                                           | ** ** | **—**                                       | ** ** | 145 |   |
| Repayment of  capital lease obligation                                                                                      | ** ** | **(11**                                          | **)**      | — |   |
| Redpoint  financing, net of $620 thousand issuance costs                                                                    | ** ** | **5,380**                                        | ** ** | — |   |
| **Net cash provided by financing activities**                                                                               | ** ** | **5,369**                                        | ** ** | 145 |   |
|                                                                                                                        |       |                                             | ** ** |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                                                               | ** ** | **67**                                           | ** ** | (27 | ) |
| **Net increase (decrease) in cash and cash equivalents**                                                                    | ** ** | **3,409**                                        | ** ** | (436 | ) |
|                                                                                                                        |       |                                             | ** ** |   |   |
| Cash and  cash equivalents at beginning of period                                                                           | ** ** | **6,778**                                        | ** ** | 4,976 |   |
|                                                                                                                        |       |                                             | ** ** |   |   |
| **Cash and cash equivalents at end of period**                                                                              | ** ** | **10,187**                                       | ** ** | 4,540 |   |
| ** **                                                                                                                  | ** ** | ** **                                       | ** ** |   |   |
| **Supplemental disclosures of cash flow  information:**                                                                     |       |                                             | ** ** |   |   |
| Income taxes paid                                                                                                           | ** ** | **4**                                            | ** ** | 5 |   |
|                                                                                                                        |       |                                             | ** ** |   |   |
| **Non-cash investing activities:**                                                                                          |       |                                             | ** ** |   |   |
| Acquisition of assets through capital lease  obligation                                                                     | ** ** | **239**                                          | ** ** | **—** |   |
| Deferred charges relating to planned  acquisition                                                                           | ** ** | **—**                                       | ** ** | 190 |   |
| Unrealized net loss from securities                                                                                         | ** ** | **—**                                       | ** ** | 1 |   |
|                                                                                                                        |       |                                             | ** ** |   |   |
| **Non-cash financing activities:**                                                                                          |       |                                             | ** ** |   |   |
| Increase in accrued dividends                                                                                               | ** ** | **15**                                           | ** ** | — |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**ANSWERS CORPORATION**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**Note 1 -Business**

 

AnswersCorporation (“the Parent”) was founded as a Texas corporation on December 22,1998, and reorganized as a Delaware corporation in April 1999. On December 27,1998, the Parent formed a subsidiary based in Israel (“the Subsidiary”),primarily for the purpose of providing research and development services to theParent. The Parent and its wholly owned Subsidiary are collectively referred toas “the Company.” The Parent is a public company and trades on the NasdaqGlobal Market under the symbol “ANSW”.

 

As of June 30, 2008, approximately $256 thousand ofthe Company’s net assets were located outside of the United States.

 

The Company provides answer-based search services to usersprimarily through its websites, Answers.com and WikiAnswers.com.

 

OnJune 16, 2008, the Company raised $6,000,000, before related fees and costs,in a private placement offering. See Note 5 for further details.

 

Inan effort to improve monetization, in the fourth quarter of 2006, the Companybegan marketing directly to advertisers and generating additional advertisingrevenue. However, at the end of the second quarter of 2008, the Company decidedto abandon that effort, and by the end of the third quarter of 2008, the directsales staff will be leaving the Company. In connection with the winding down ofthis effort, the Company recorded a charge of $90,000, in the second quarter of2008, to account for the estimated cost of terminating certain related servicecontracts and employment agreements.

 

Inthe second quarter of 2008, the Company abandoned its use of the BrainboostAnswer Engine (see Note 4).

 

Inthe first quarter of 2008, the Company’s planned acquisition of LexicoPublishing Group LLC and the related planned offering of securities wereterminated due to unfavorable market conditions. As a result, the Companyrecorded a charge to its statement of operations, amounting to approximately$2.54 million. See Note 8 (g) for further details.

 

**Note 2 - Summaryof Significant Accounting Policies**

 

**Basis of Presentation**

 

Theaccompanying consolidated financial statements include the accounts of AnswersCorporation and its Subsidiary and are presented in accordance with accountingprinciples generally accepted in the United States. All significantintercompany balances and transactions have been eliminated in consolidation.

 

Theaccompanying unaudited consolidated financial statements were prepared inaccordance with the instructions for Form 10-Q and, therefore, do notinclude all disclosures necessary for a complete presentation of financialcondition, results of operations, and cash flows in conformity with generallyaccepted accounting principles. All adjustments, which are, in the opinion ofmanagement, of a normal recurring nature and are necessary for a fairpresentation of the interim financial statements, have been included.Nevertheless, these financial statements should be read in conjunction with theconsolidated financial statements and related notes included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2007. Theresults of operations for the three and six months ended June 30, 2008 arenot necessarily indicative of the results that may be expected for the entirefiscal year or any other interim period.

 

**Use of Estimates**

 

The preparation of consolidated financial statements inconformity with generally accepted accounting principles in the United Statesof America requires management to make certain estimates and assumptions thataffect 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.

 

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**ANSWERS CORPORATION**

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

**(UNAUDITED)**

 

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

 

**Revenue Recognition**

 

The Company, through its websites Answers.com and WikiAnswers.com,generates revenues via advertising in the form of sponsored links and imageads. This includes both pay-per-performance ads and paid-for-impressionadvertising. In the pay-per-performance model, the Company earns revenue basedon the number of clicks associated with such ads. In the paid-for-impressionmodel, the Company’s revenue is derived from the display of ads.

 

The majority of the Company’s advertising revenue has beenobtained through the efforts of third parties and has not been the result ofdirect contracts with advertisers. The third party is obligated to pay theCompany a portion of the revenue it receives from advertisers, as compensationfor the Company’s sale of promotional space on its Internet properties. Amountsreceived from such third parties are reflected as revenue in the period inwhich such advertising services are provided.

 

The Company also earns revenuesfrom partners that pay the Company for providing them with answer-basedservices that they then use in their own products, via co-branded web pages.

 

In 2003, the Company sold lifetime subscriptions to itsGuruNet product, which had no defined termination date. Cash received from suchlifetime subscriptions was recorded as deferred revenues and amounted to$425,000. In February 2007, in accordance with the Company’s rights underthe agreements it previously entered into with such lifetime subscribers, theCompany terminated its GuruNet service and thereby extinguished its serviceobligation to such subscribers. Thus, the Company recognized the $425,000previously deferred, as revenue in the first quarter of 2007.

 

The Company earnedadvertising revenue from its two web properties, as follows:

 
| ** **              | ** ** | **Three months ended June 30** | ** ** | **Six months ended June 30** | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                           | ** ** | **2007**                                         | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **              | ** ** | **$ (in thousands)**                     | ** ** |
|                    |       |                                               |       |                                             |       |   |   |   |   |
| **Advertising revenue** |       |                                               |       |                                             |       |   |   |   |   |
|                    |       |                                               |       |                                             |       |   |   |   |   |
| Answers.com             |       | 1,485                                              |       | 2,551                                            |       | 3,313 |   | 5,319 |   |
| WikiAnswers             |       | 1,500                                              |       | 177                                              |       | 2,685 |   | 293 |   |
| ** **              | ** ** | **2,985**                                          | ** ** | **2,728**                                        | ** ** | **5,998** | ** ** | **5,612** | ** ** |

 

**Accounting for Stock-Based Compensation**

 

The fair value of stockoptions granted to employees and directors, is estimated at the date of grantusing the Black-Scholes option-pricing model, which takes into considerationthe share price at the date of grant, the exercise price of the option, the expectedlife of the option, expected interest rates and the expected 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 on its own historicalstock volatility rates only.

 

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**ANSWERS CORPORATION**

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

**(UNAUDITED)**

 

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

 

**Net Loss per Common Share**

 

Basicand diluted net loss per common share is computed by dividing the net lossattributable to common stockholders by the weighted average number of commonshares outstanding for the period. Diluted net loss per share is the same as basic net loss per share asthe inclusion of the Company’s outstanding common stock equivalents would beanti-dilutive.

 

The table below presents thecomputation of basic and diluted net loss per common share:

 
| ** **                                                                                    | ** ** | **Three months ended June 30**                                            |       | **Six months ended June 30** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2008**                                                                                      | ** ** | **2007**                                         |       | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                    | ** ** | **$ (in thousands, except share and per share data)** | ** ** |
|                                                                                          |       |                                                                                          | ** ** |                                             |       |   | ** ** |   |   |
| **Net loss**                                                                                  | ** ** | **(4,619**                                                                                    | **)**      | (1,247                                           | )          | **(8,286** | **)** | (1,550 | ) |
|                                                                                          |       |                                                                                          | ** ** |                                             |       |   | ** ** |   |   |
| Series A Convertible Preferred Stock  dividends                                          |       | (15                                                                                           | )          | —                                           |       | (15 | ) | — |   |
| Amortization of Series A Convertible  Preferred Stock discounts                          |       | (40                                                                                           | )          | —                                           |       | (40 | ) | — |   |
|                                                                                          |       |                                                                                          | ** ** |                                             |       |   | ** ** |   |   |
| **Net loss attributable to common shares**                                                    | ** ** | **(4,674**                                                                                    | **)**      | (1,247                                           | )          | **(8,341** | **)** | (1,550 | ) |
|                                                                                          |       |                                                                                          | ** ** |                                             |       |   | ** ** |   |   |
| **Weighted average shares used in computing****basic and  diluted net loss per common share** | ** ** | **7,859,890**                                                                                 | ** ** | 7,853,818                                        |       | **7,859,890** | ** ** | 7,840,140 |   |
|                                                                                          |       |                                                                                          | ** ** |                                             |       |   | ** ** |   |   |
| **Basic and diluted net loss per common share**                                               | ** ** | **(0.59**                                                                                     | **)**      | (0.16                                            | )          | **(1.06** | **)** | (0.20 | ) |

 

**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, orfirm commitments through earnings, or recognized in other comprehensive incomeuntil the hedged item is recognized in earnings. The ineffective portion of aderivative’s change in fair value is recognized in earnings.

 

During the first half of 2008,the Subsidiary entered into option contracts to hedge certain foreign currencydenominated expenses. These derivatives were not designated as hedginginstruments under the rules of SFAS 133 and, therefore, the net gains(losses) are recognized in earnings as they occur. Such gains amounted to $90thousand, and are included in operating expenses as follows:

 
| ** **                 | ** ** | **$ (in thousands)** | ** ** |
|----------------------------|------------|--------------------------------|------------|
|                       |       |                           |       |
| Cost of revenue            |       | 12                             |       |
| Research and development   |       | 48                             |       |
| Sales and marketing        |       | 4                              |       |
| General and administrative |       | 26                             |       |
|                       |       |                           |       |
|                       |       | 90                             |       |

 

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**ANSWERS CORPORATION**

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

**(UNAUDITED)**

 

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

 

**RecentlyIssued Accounting Standards**

 

In March 2008, theFASB issued 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 currentlyevaluating the potential impact of the adoption of SFAS 161 on its consolidatedfinancial position, results of operations or cash flows.

 

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. The Companyis currently evaluating the potential impact of the adoption of FSP APB 14-1 on its consolidatedfinancial 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 8 (b)). The capitalized leases are included in property andequipment as follows:

 
| ** **                      | ** ** | **As of June 30** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ** **                      | ** ** | **$ (in thousands)**   | ** ** |
|                            |       |                             |       |   |   |
| Computer  equipment             | ** ** | **239**                          |       | — |   |
| Less:  accumulated depreciation | ** ** | **(18**                          | **)**      | — |   |
|                            |       |                             |       |   |   |
| ** **                      |       | **221**                          |       | — |   |

 

**Note 4 –Brainboost Answer Engine**

 

InDecember 2005, the Company acquired Brainboost Technology, LLC, developerof the Brainboost Answer Engine (“BAE”), an artificial intelligence technologyenabling natural language question-and-answer search on the Web. Asconsideration for the acquisition, the Company paid $4.0 million in cash and439,000 shares of its restricted stock, valued at approximately $5.6 million atthe time of the acquisition. In connection with the initial allocation of thepurchase price, the Company recorded an intangible asset, with an estimateduseful life of six years, of approximately $5.4 million.

 

Inthe second quarter of 2008, the Company decided to focus its efforts, in therealm of questions-and-answers, solely on user-generated,questions-and-answers, and effectively abandoned its use of the BAE. Thisdecision was implemented on May 25, 2008, when changes were made toAnswers.com, virtually eliminating the use of the BAE. Additionally, theCompany no longer has any staff assigned to this project, has no plans toreinstate the use of the BAE and considers it to have no further servicepotential.

 

Asa result of the Company’s decision to effectively abandon its use of the BAE,the net book value of the BAE as of May 25, 2008, in the amount of$3,138,000, was written off, and the resulting charge is included in theCompany’s operating expenses for the three and six months ended June 30,2008.

 

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**ANSWERS CORPORATION**

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

**(UNAUDITED)**

 

**Note 5 – Redpoint Financing**

 

On June 16, 2008,pursuant to a private placement of the Company’s securities, Redpoint Omega,L.P. and Redpoint Omega Associates, LLC (collectively, “Redpoint”) purchased$6,000,000 of the Company’s Series A Convertible Preferred Stock,initially convertible into 1,333,333 shares of common stock at a conversionprice of $4.50 per share, and Common Stock Purchase Warrants exercisable for666,667 shares of common stock at an exercise price of $4.95 per share (“Series AWarrants”). Redpoint also received a warrant, exercisable until June 16,2009, to purchase units of up to $7 million of Series B ConvertiblePreferred Stock and Common Stock Purchase Warrants exercisable for 636,364shares 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 B Warrantshave an exercise price of $6.05 per share. After deducting placement agent feesand legal expenses, the Company’s net proceeds from the private placement wereapproximately $5,380,000. The Series A Convertible Preferred Stock, the Series BConvertible Preferred Stock, the Series A Warrants and the Series BWarrants are collectively referred to as the “Redpoint Securities”. The warrantto purchase units of Series B Convertible Preferred Stock and Series BWarrants is referred to as the “Unit Warrant”.

 

The Series AConvertible Preferred Stock has the rights and preferences set forth in theCompany’s Certificate of Designations, which amended the Company’s Amended andRestated Certificate of Incorporation as of its date of filing on June 16,2008 (see Note 6). The Series B Convertible Preferred Stock, if purchasedby Redpoint pursuant to its Unit Warrant, will have similar rights andpreferences as the Series A Convertible Preferred Stock.

 

Inconnection with the private placement the Company entered into a registrationrights agreement with Redpoint, pursuant to which the Company agreed toregister with the SEC for resale the common stock underlying the RedpointSecurities. In connection with the registration rights agreement, the Companyagreed to pay a penalty of 1.0% per month, on a daily pro rata basis, up to amaximum of 8.0%, of the aggregate purchase price, as partial liquidateddamages, for certain default events and subject to certain circumstances. Thepartial liquidated damages will trigger if the registration statement is notfiled by August 15, 2008, or if the Company fails to file a request foracceleration of effectiveness, or if the registration statement is not declaredeffective by November 13, 2008, or ceases to remain continuously effective.The Company also agreed to use its reasonable best efforts to obtain allrequired stockholder approval for the authorization and issuance of the commonstock underlying the Redpoint Securities by September 15, 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 Unit Warrant and meets certain ownership requirements, it will beentitled to appoint a second member to the Company’s board of directors.

 

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

**(UNAUDITED)**

 

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

 

**Accounting**

 

The$6,000,000 of proceeds from the Redpoint Financing were first allocated to theUnit Warrant, which has been classified as a liability, based on its fairvalue, and the residual amount was allocated among the Series AConvertible Preferred Stock and the Series A Warrants based on theirrelative fair values, all in accordance with the guidance in SFAS 150, *“Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity”*, and EITF 00-19, *“Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock”*. The Series AConvertible Preferred Stock has been classified as temporary equity, inaccordance with the guidance in EITF D-98, *“Classificationand Measurement of Redeemable Securities”*, and the Series AWarrants have been classified in permanent equity.

 

Inrecording the effects of the transaction, the Company allocated theconsideration from the purchase of the Redpoint Securities as follows:

 
| ** **              | ** ** | **Series A  Convertible  Preferred Stock** | ** ** | **Series A  Warrants** | ** ** | **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     |       |

 

Transactioncosts were allocated on a pro rated basis, based on the amounts allocated toeach of the components of the transaction. Transaction costs relating to the Series AConvertible Preferred Stock and Series A Warrants have been reflected as areduction to the proceeds from the issuance of such instruments. Transactioncosts relating to the Unit Warrant have been deferred and are being amortizedto interest expense over one year, which is the life of the warrant.

 

**Series A Convertible Preferred Stock**

 

Inaccordance with guidance in EITF D-98, *“Classificationand Measurement of Redeemable Securities”*and other accountingliterature, the Series A Convertible Preferred Stock has been recorded atits initial relative fair value and classified in temporary equity. Subsequentchanges to its fair value will not be recognized as long as the stock continuesto be classified as temporary equity and not as a liability.

 

**Series A Warrants**

 

Therelative fair value of the Series A Warrants, as explained above, has beenrecorded and classified as additional paid in capital in permanent equity, asdescribed above, with a corresponding discount to the Series A ConvertiblePreferred Stock. Such discount is amortized to paid-in capital through theearliest redemption date of the stock, which is six years after the date ofissuance. As of June 30, 2008, approximately $3,000 of such discount hasbeen amortized.

 

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

**(UNAUDITED)**

 

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

 

**Unit Warrant**

 

TheUnit Warrant has been recorded as a liability, with a corresponding discount tothe Series A Convertible Preferred Stock. Such discount is amortized against paid-in capital through the earliestredemption date of the stock, which is six years after the date of issuance. Asof June 30, 2008, approximately $25,000 of such discount has beenamortized.

 

TheUnit Warrant will be revalued each reporting date. Any changes to its fairvalue will be recorded in the statement of operations as interest expense. TheCompany assessed the value of the Unit Warrant as of June 30, 2008, ascompared to its value on the date of the Redpoint Financing, June 16,2008. The change in value was not recorded in the statements of operations forthe three and six months ended June 30, 2008, since it was immaterial.

 

**Beneficial Conversion Feature**

 

Resultingfrom the allocation of the proceeds as described above, and in comparison tothe fair market value of the Company’s common stock on the date of issuance,the effective conversion rate of the Series A Convertible Preferred Stock,represents an additional beneficial conversion value. Thus, the Companyrecorded an additional discount to the Series A Convertible PreferredStock, with a corresponding increase in paid-in capital, of $1,768,000,reducing the Series A Convertible Preferred Stock to zero. In accordancewith EITF 00-27, *“Application of Issue No. 98-5to Certain Convertible Instruments”*, the aforesaid discount isamortized to paid-in capital over six years from the date of issuance, theearliest redemption date of the stock. As of June 30, 2008, approximately$12,000 of such discount has been amortized.

 

Thereare additional features of the Series A Convertible Preferred Stock whichrepresent contingent beneficial conversion features, to be reevaluated in thefuture. In the event that the facts and circumstances indicate that acontingency is removed, at that point the beneficial conversion feature, ifany, will be recorded.

 

**Dividends**

 

The Series AConvertible Preferred Stock accrues cumulative dividends at a rate of 6% perannum whether or not dividends have been declared by the Company’s Board ofDirectors 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 - Series AConvertible Preferred Stock**

 

The following table summarizes the changes in the Series AConvertible Preferred Stock resulting from issuance through June 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 Unit Warrant           |       | (3,511                    | )          |
| Discount  resulting from the Beneficial Conversion Feature          |       | (1,768                    | )          |
| Amortizations  of discounts from closing through June 30, 2008 |       | 40                        |       |
| Accrued  dividends                                                  |       | 15                        |       |
| ** **                                                          | ** ** | ** **                | ** ** |
| ** **                                                          | ** ** | **55**                    | ** ** |

 

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**ANSWERS CORPORATION**

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

**(UNAUDITED)**

 

**Note 6 - Series AConvertible Preferred Stock****(cont’d)**

 

As a result of the RedpointFinancing (see note 5), the Company’s Amended and Restated Certificate ofIncorporation has been amended to provide for the issuance of up to 60,000shares of Series A Convertible Preferred Stock with a stated value of $100per share (the “Stated Value”) pursuant to the Certificate of Designations,Number, Voting Powers, Preferences and Rights of Series A ConvertiblePreferred Stock filed with the State of Delaware on June 16, 2008 (the “Certificateof Designations”).

 

TheCertificate of Designations provides for the following rights and preferences:

 

**Dividends**

 

The Series AConvertible Preferred Stock will accrue cumulative dividends at a rate of 6%per annum whether or not dividends have been declared by the Board of Directorsand whether or not there are profits, surplus or other funds available for thepayment of such dividends.  Dividends may be payable in kind at the optionof the Company upon satisfaction of certain conditions.

 

**VotingRights**

 

The Series AConvertible Preferred Stock shall vote on an as converted basis with theCompany’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**

 

Upon an event ofliquidation, 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.

 

**Conversionsat Option of Holder**

 

Each share of Series AConvertible Preferred Stock shall be convertible into that number of shares ofcommon stock (“Common Stock”) determined by dividing the Stated Value plus anyaccrued but unpaid dividends thereon (to the extent not already included in theStated Value) of such share of Series A Convertible Preferred Stock by$4.50 (the “Conversion Price”), at the option of the Holder, at any time andfrom time to time.

 

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**ANSWERS CORPORATION**

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

**(UNAUDITED)**

 

**Note 6 - Series AConvertible Preferred Stock****(cont’d)**

 

**MandatoryConversion**

 

Beginning December 16,2009, provided certain conditions are satisfied, if the closing price of theCommon Stock equals an average of $13.50 (subject to adjustment for stocksplits, reclassifications, combinations and similar adjustments) per share forthe 45 consecutive trading days immediately prior to the Automatic ConversionNotice Date (as defined below), and average daily volume of the Common Stock onThe Nasdaq Global Market averages at least $1,000,000 during such measurementperiod, unless the Holder is prohibited from converting the Series AConvertible Preferred Stock pursuant to certain limitations set forth in theCertificate of Designations, the Company shall have the right to deliver anotice to the Holder (an Automatic Conversion Notice, and the date such noticeis received by the Holder, the Automatic Conversion Notice Date), to convertany portion of the shares of Series A Convertible Preferred Stock thenheld by the holder into shares of Common Stock at the then-effective ConversionPrice.

 

**Redemption**

 

At anytime on or after June 16,2014, upon written request by the majority of the Holders, the Company shallredeem all or any portion of the then outstanding Series A Convertible PreferredStock, for an amount in cash equal to the sum of (i) 100% of the aggregateStated Value then outstanding and (ii) accrued but unpaid dividends (tothe extent not already included in Stated Value) and (iii) all liquidateddamages and other amounts due in respect of the Series A ConvertiblePreferred Stock.

 

**SubsequentEquity Sales**

 

If the Company, at any timewhile Series A Convertible Preferred Stock is outstanding, shall sell orgrant any option to purchase or otherwise dispose of or issue any Common Stockor Common Stock equivalents entitling any person to acquire shares of CommonStock, at an effective price per share less than the then effective ConversionPrice, then, the Conversion Price shall be adjusted on a broad weighted averagebasis.

 

**ParticipationRights**

 

At any time while Series AConvertible Preferred Stock is outstanding (or the Common Stock issuable orissued upon conversion thereof) and the Holders or their affiliatescollectively hold a majority of the outstanding Series A ConvertiblePreferred Stock (or the Common Stock issuable or issued upon conversionthereof) 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.

 

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**ANSWERS CORPORATION**

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

**(UNAUDITED)**

 

**Note 7 –Stockholders’ Equity**

 

**General**

 

The following table summarizes the changes in theCompany’s stockholders’ equity during the six-month period ending June 30,2008:

 
| ** **                                                          | ** ** | **$ (in thousands)** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------|------------|
|                                                                |       |                           |       |
| **December 31, 2007**                                          | ** ** | **14,771**                     | ** ** |
|                                                                |       |                           |       |
| Stock-based  compensation                                           |       | 921                            |       |
| Discount  resulting from the issuance of the Series A Warrants |       | 463                            |       |
| Discount  resulting from the Beneficial Conversion Feature          |       | 1,768                          |       |
| Amortizations  of discounts from closing through June 30, 2008 |       | (40                            | )          |
| Accrued  dividends                                                  |       | (15                            | )          |
| Net loss for  the period                                            |       | (8,286                         | )          |
| ** **                                                          | ** ** | ** **                     | ** ** |
| **June 30, 2008**                                              | ** ** | **9,582**                      | ** ** |

 

**StockWarrants**

 

As of June 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 six months ended June 30, 2008.

 

**Stock Options**

 

During the six months ended June 30,2008, the Company granted a total of 60,500 stock options to its employees andofficers at an average exercise price of $4.19 per option. All such optionswere granted under the Company’s 2005 Plan. Additionally, during the sameperiod, 47,829 stock options were forfeited.

 

As of June 30, 2008,95,505 and 116,360 options were available for grant under the 2005 Plan and the2004 Stock Plan, respectively. All Prior Option Plans are closed for futuregrants.

 

The total fair value of stock options vested during thefirst half of 2008, amounted to $921 thousand and was recorded as stock-basedcompensation expense. Nostock options were exercised during the six months ended June 30, 2008.

 

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

**(UNAUDITED)**

 

**Note 8 - Commitments and Contingencies**

 

(a)          Future minimum lease payments under non-cancelableoperating leases for office space and cars, as of June 30, 2008, are asfollows:

 
| **Year ending December 31**       | ** ** | **$ (in thousands)** | ** ** |
|--------------------------------------------------|------------|--------------------------------|------------|
|                                             |       |                           |       |
| 2008 (six  months ending December 31, 2008) |       | 224                            |       |
| 2009                                             |       | 403                            |       |
| 2010                                             |       | 241                            |       |
| 2011                                             |       | 1                              |       |
| ** **                                       | ** ** | ** **                     | ** ** |
|                                             | ** ** | 869                            | ** ** |

 

Rental expense for operating leases for the three monthsended June 30, 2008 and 2007, was approximately $139,000, and $122,000,respectively. Rental expense for operating leases for the six months ended June 30,2008 and 2007, was approximately $272,000, and $240,000, respectively.

 

(b)         Futureminimum lease payments under non-cancelable capital leases for computerequipment, as of June 30, 2008, are as follows:

 
| **Year ending December 31**       | ** ** | **Principal**                  | ** ** | **Interest** | ** ** |
|--------------------------------------------------|------------|--------------------------------|------------|--------------|------------|
|                                             |       | **$ (in thousands)** |       |
|                                             |       |                           |       |         |       |
| 2008 (six  months ending December 31, 2008) |       | 38                             |       | 5            |       |
| 2009                                             |       | 78                             |       | 8            |       |
| 2010                                             |       | 82                             |       | 3            |       |
| 2011                                             |       | 30                             |       | 1            |       |
| ** **                                       | ** ** | ** **                     | ** ** | ** **   | ** ** |
|                                             |       | 228                            |       | 17           | ** ** |

 

(c)          Abank guarantee given to the Subsidiary’s landlord, is secured by a restrictedlong-term deposit of $163,000 and collateralized by some of the Subsidiary’sbank deposits (as of June 30, 2008, such deposits amounted to $557,000).

 

(d)         Inthe ordinary course of business, the Company enters into various arrangementswith vendors and other business partners, principally for content, web-hosting,marketing and various consulting arrangements. As of June 30, 2008, thetotal future commitments under these arrangements amount to approximately$572,000.

 

(e)          Inthe ordinary course of business, the Company may provide indemnifications ofvarying scope and terms to customers, vendors, lessors, business partners, andother parties with respect to certain matters, including, but not limited to,losses arising out of its breach of agreements, services to be provided by it,or from intellectual property infringement claims made by third parties.Additionally, the Company, through its operating agreement, has indemnified itsmembers, officers, employees, and agents serving at the request of the Companyto the fullest extent permitted by applicable law. It is not possible todetermine the maximum potential amount of liability under these indemnificationagreements due to the limited history of prior indemnification claims and theunique facts and circumstances involved in each particular agreement. Suchindemnification agreements may not be subject to maximum loss clauses. To date,the Company has not incurred costs as a result of obligations under theseagreements and has not accrued any liabilities related to such indemnificationobligations in its accompanying financial statements.

 

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

**(UNAUDITED)**

 

**Note 8 - Commitments and Contingencies (cont’d)**

 

(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.

 

(g)         OnJuly 13, 2007, the Company entered into a Purchase Agreement to acquireall of the outstanding limited liability interests of Lexico Publishing Group,LLC for an aggregate purchase price of $100 million in cash, subject toadjustments for closing net working capital. Consummation of the acquisition ofLexico was subject to the Company’s ability to secure financing for theacquisition.

 

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 andaccounting expenses, 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$1,270,000 and $348,000 of costs, including legal, accounting, banking,consulting and travel costs, in 2007 and in the first quarter of 2008,respectively, in connection with the proposed acquisition of Lexico andfollow-on offering. The payments to Lexico, to the senior notes investor, andthe additional costs, collectively $2,543,000, are included in the operatingexpenses on the Company’s statement of operations for the six months ended June 30,2008.

 

**Note 9 – Major Customer**

 

Duringthe first half of 2008, the majority of the Company’s advertising revenue wasgenerated through the efforts of third party suppliers (the “MonetizationPartners”). During the three months ending June 30, 2008, the Companyearned approximately 78% of its advertising revenue through one of itsMonetization Partners, compared to 73% of advertising revenue from thatMonetization Partner during the second quarter of 2007. Additionally, duringthe six months ending June 30, 2008, the Company earned approximately 77%of its advertising revenue through one of its Monetization Partners, comparedto 71% of advertising revenue from that Monetization Partner during the sameperiod in 2007.

 

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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 are a leading onlineanswer engine. Our Web properties consist of Answers.com and WikiAnswers.com.We offer information related to over 5 million topics based on contentfrom brand-name publishers, and our WikiAnswers community. Answers.com combinesand presents targeted information from disparate sources and delivers answersto users’ questions in a single consolidated view. WikiAnswers.com is auser-generated content, or UGC, community-based question and answer site.According to comScore, a global Internet information provider, our Webproperties had approximately 15.8 million unique visitors in June 2008,which ranks Answers Corporation number 55 in the top U.S. Web properties.Our goal is to become the premier online provider of, and leading destinationfor, answers on any topic.

 

**RecentEvents**

 

***Redpoint Financing***

 

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”).  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 its unitwarrant, 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.

 

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 is not filed by August 15, 2008, or if wefail to file a request for acceleration of effectiveness, or if theregistration statement is not declared effective by November 13, 2008, orceases to remain continuously effective. We also agreed to use our reasonablebest efforts to obtain all required stockholder approval for the authorizationand issuance of the common stock underlying the Redpoint Securities by September 15,2008.

 

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 its unit warrant and meetscertain ownership requirements, it will be entitled to appoint a second memberto our board.

 

***Write-off of 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.

 

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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 thetechnology-driven answers presented by the BAE, we made a strategic decision inthe second quarter of 2008 to focus our efforts, in the realm ofquestions-and-answers, on user-generated questions and answers, and effectivelyabandoned our use of the BAE. This strategic decision is reflected in a changewe made to Answers.com on May 25, 2008. Prior to that date, users asking a question on Answers.com caused thesite to access the BAE in an attempt to locate an answer on the Web.  The BAE results were then presented on theAnswers.com result page. Beginning May 25, 2008, users no longer receiveBAE-derived result pages, rather they are instead encouraged to post theirquestion to WikiAnswers, and in a less pronounced fashion, offered a link toanother page for purposes of accessing BAE should they wish to do so. Thisuser-interface change virtually eliminated the use of the BAE as demonstratedby the elimination of virtually all BAE-derived page views. Additionally,we no longer have any staff assigned to BAE development. We have no plans toreinstate the use of the BAE and consider it to have no further servicepotential.

 

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.

 

***Suspension of Direct Ad Sales***

 

Inan effort to improve monetization, in the fourth quarter of 2006, we beganmarketing directly to advertisers and generating additional advertisingrevenue. However, at the end of the second quarter of 2008 we decided toabandon our direct ad sales efforts, and by the end of the third quarter of2008, our direct sales staff will be leaving the Company. In connection withthe winding down of this effort, we recorded a charge of $90 thousand, in thesecond quarter of 2008, to account for the estimated cost of terminatingcertain related service contracts and employment agreements.

 

**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 submit queries andalgorithm 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 second quarter of 2008, according to ourinternal estimates, this source of traffic represented approximately 73% of ourtraffic.

 

·             *Direct users:*  Users visiting and returning toour home pages, and to a far lesser extent, arriving from Web properties thatsend us traffic, or via 1-Click Answers and AnswerTips. For the second quarterof 2008, according to our internal estimates, direct users representedapproximately 20% of our traffic.

 

·             *Google’s definition link:*  We have an informal,non-contractual relationship with Google under which Google links certainsearch results related to definitional queries to Answers.com. For the secondquarter of 2008, according to our internal estimates, this source of trafficrepresented approximately 7% 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. Inresponse to the Google algorithm adjustment, in August 2007, we reducedour headcount and related compensation costs, reducing our base payrollexpenses by approximately 12%.

 

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.

 

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***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.Historically, we tracked the traffic on our Answers.com and WikiAnswers Webproperties 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.

 

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. Beginningwith this report, all traffic measurements (including measurements previouslyreported in past filings using our Internal Data Warehouse) for Answers.comwill also be presented based on the HBX Analytics data. We estimate that thehistorical page views for Answers.com pursuant to HBX Analytics data, asset forth in this quarterly report, are approximately 11% lower than thetraffic measurements reported in previous filings. Consequently, ourAnswers.com RPMs, as reported in this quarterly report, are higher thanpreviously reported.

 

We also use Google, Inc.’sGoogle Analytics measurement services for various internal analyses. Further,our breakdown of our traffic sources, noted above, is based on the Googleanalytics data. These measurements are generated by our placement of tags onour Web properties’ pages, which Google Analytics uses to count and reportaudience metrics independently.

 

Two of our third party adnetworks, Google and Shopping.com, accounted for approximately 77% and 4%,respectively, of our total revenue in the second quarter of 2008 andapproximately 71% and 10%, respectively, of our total revenue in the secondquarter of 2007. They accounted for approximately 77% and 5% respectively, ofour total revenue in the first six months of 2008 and approximately 65% and10%, respectively, of our total revenue in the first six months of 2007. Inaddition to Google and Shopping.com, we utilize the services of other thirdparty ad networks that provide us with ads. Although there are many companiesthat provide third party ad networks, the loss of Google as a third party adnetwork could have a material adverse impact on our financial condition, as wemay not succeed in receiving terms and ad services as favorable as thoseprovided under our Google Services Agreement (GSA). While the drop in trafficdue to the July 2007 Google search engine algorithm adjustment impactedour aggregate advertising revenue, it did not affect our contractualrelationship with Google under the GSA, which was last renewed for anadditional two 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 will 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. We now believe that thehorizontal, educational, reference nature of www.answers.com makes direct adsless compelling for this Web property. While we view WikiAnswers as having thepotential to successfully implement a direct ad sales strategy, we have decidednot to take that route and to instead focus on selling ads through advertisingnetworks, primarily Google AdSense. This decision will allow us to focus on ourcore competency — growing the WikiAnswers community, growing traffic to our Webproperties and monetizing via Google and other ad networks. In connection withthe winding down of our direct ad sales efforts, we recorded a charge of $90thousand in the second quarter of 2008, to account for the estimated cost ofterminating certain related service contracts and employment agreements.

 

*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.

 

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**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 a result of our migration to a co-location facility forhosting our Web properties from managed hosting, a process we expect toconclude in 2008, we expect our unit production operations costs to decline.Further, as revenues increase, we expect our cost of revenue as a percentage ofrevenue to decrease, since many of its components, such as content 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 user interface, product functionality, monetization,disambiguation, scalability and performance. We generally expect that ourresearch and development expenses will decline as a percentage of revenue as wegrow our revenue.

 

***Sales and Marketing Expenses***

 

Sales and marketing expensesconsist of compensation, travel and overhead costs of personnel in-charge ofsales and marketing, WikiAnswers community management, and product management,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.Overhead costs consist primarily of rent, telecommunications, utilities anddepreciation expenses. We generally expect that our general and administrativeexpenses will decline as a percentage of revenue as we grow our revenue.

 

***Write-off of the Brainboost AnswerEngine***

*** ***

As a result of our decision to effectively abandon our use of theBAE, the net book value of the BAE was written off and the resulting charge of$3,138 thousand is included in our statement of operations for the three andsix months ended June 30, 2008.

 

***Termination fees and write-off of cost relating to the terminatedLexico 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 follow-on offering. A summary of theevents that led to the termination of the acquisition and follow-on offeringfollows:

 

On July 13, 2007, weentered into a Purchase Agreement that we subsequently amended on July 31, 2007and November 12, 2007, and on January 15, 2008 we entered into an Amended andRestated 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 filed auniversal shelf registration statement on Form S-3 with the Securities andExchange Commission which was declared effective on August 6, 2007.  The registration statement covers up to an aggregateof $140 million of common stock, preferred stock, warrants, debt securities,units or any combination thereof. On January 16, 2008, we filed a prospectussupplement for a proposed public offering which we later amended on February 8,2008.  On February 13, 2008 we canceledour proposed public offering due to unfavorable market conditions. On March 1,2008, the members of Lexico terminated the purchase agreement, due to ourinability to finance the acquisition. Additionally, in connection with the Lexico transaction, onJanuary 15, 2008, we entered into a Securities Purchase Agreement with aninstitutional investor, or the senior notes investor, for the optional purchaseand sale of $8.5 million of our senior secured convertible notes. Ourintent was to close the senior secured convertible notes financing inconjunction with our follow-on offering, if we needed such funds to close theLexico acquisition. Since our purchase agreement with Lexico was terminated,the Securities Purchase Agreement also terminated.

 

***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*

 

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*Payments”,*or SFAS 123R, which requires measurement of compensation cost forall stock-based awards at fair value on date of grant and recognitionof compensation 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 endedJune 30, 2008, the average value of the dollar declined approximately 16%, ascompared to its value during the same period in 2007. In the six months endedJune 30, 2008, the average value of the dollar declined approximately 15%, ascompared to its value during the same period in 2007. During the three and sixmonths ending June 30, 2008, approximately $1.4 million and $2.7 million of ourexpenses, 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.

 

***Interest Income Net***

 

Interest income, netprimarily consists of interest income earned on cash, cash equivalent and aninvestment security balances.

 

***Other Expenses***

 

Other expenses consistprimarily of foreign currency exchange gains and losses.

 

***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.

 

Our Israeli subsidiary hadincome in the three months ended June 30, 2008 and 2007, resulting from theservices agreement we entered into with such Israeli subsidiary. Pursuant tothis agreement, the Israeli subsidiary charges us for research and developmentservices it provides us, plus a profit margin not more than 12.5%. However, thesubsidiary is an “approved enterprise” under Israeli law, which means thatincome arising from the subsidiary’s approved activities, is subject to zerotax under the “alternative benefit” path for a period of ten years. Currently,the subsidiary operates under two separate “approved enterprise” plans, endingDecember 31, 2009 and December 31, 2014, respectively. In the event ofdistributions by the subsidiary to the parent, the subsidiary would have to paya 10% corporate tax on the amount distributed, and the recipient would have topay a 15% tax to be withheld at source on the amounts of such distributionreceived. At present, we do not plan on having the subsidiary distribute adividend to Answers Corporation.

 

***Three Months and Six Months Ended June 30, 2008 and 2007***

 

*Revenue*

 
| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                         | ** ** | **($ - in thousands)**               | ** ** | **($ - in thousands)**             | ** ** |
|                               |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Answers.com advertising revenue    |       | 1,485                                               |       | 2,551                                             |       | (1,066 | ) | 3,313 |   | 5,319 |   | (2,006 | ) |
| WikiAnswers advertising revenue    |       | 1,500                                               |       | 177                                               |       | 1,323 |   | 2,685 |   | 293 |   | 2,392 |   |
| Answers services licensing revenue |       | 18                                                  |       | 82                                                |       | (64 | ) | 36 |   | 159 |   | (123 | ) |
| Subscription revenue               |       | —                                              |       | —                                            |       | — |   | — |   | 425 |   | (425 | ) |
|                               |       | 3,003                                               |       | 2,810                                             |       | 193 |   | 6,034 |   | 6,196 |   | (162 | ) |

 

Revenue increased $193thousand, or 7%, to $3,003 thousand for the three months ended June 30, 2008from $2,810 thousand for the three months ended June 30, 2007.

 

 Answers.com advertising revenue for the threemonths ended June 30, 2008 decreased $1,066 thousand compared to the threemonths ended June 30, 2007, mostly due to decreases in traffic.  Answers.com average daily page views in thethree months ended June 30, 2008 were 2,641,000, a decline of 41% compared tothe average daily page views of 4,441,000 in the three months ended June 30,2007. The Answers.com RPM in the three months ended June 30, 2008 was $6.18, adecline of 2% compared to the RPM of $6.31 in the three months ended June 30,2007. The decline in traffic is primarily due to the July 2007 Google algorithmchange that significantly impacted Answers.com 

 

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traffic, reducing our overall traffic by approximately 28% based on theaverage traffic directed to Answers.com from Google for the week prior to the adjustment as compared to the week after. As aresult, our revenue also declined proportionately.

 

Answers.com advertisingrevenue for the six months ended June 30, 2008 decreased $2,006 thousandcompared to the six months ended June 30, 2007, mostly due to decreases intraffic.  Answers.com average daily pageviews in the six months ended June 30, 2008 were 2,933,000, a decline of 38% compared to the averagedaily page views of 4,693,000 in the six months ended June 30, 2007. TheAnswers.com RPM in the six months ended June 30, 2008 was $6.20, a decline of1% compared to the RPM of $6.27 in the six months ended June 30, 2007. The declinein traffic is primarily due to the July 2007 Google algorithm change thatsignificantly impacted Answers.com traffic, reducing 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 also declined proportionately.

 

Since the Google adjustment,we suspended our strategy of licensing new content, and, consequently, we areexperiencing declines in Answers.com traffic. Historically, we operated on thepremise that adding rich unique content to Answers.com positively impacted thesite’s traffic growth, guided by the principle that rich unique content was notonly appreciated by the human user, rather, it was also highly valued by thesearch engines and their content indexing programs. While Answers.com receivessignificant SEO traffic to its rich content pages, the Google algorithm changecaused us to doubt whether licensing additional content would yield a positivereturn. In recent months we made certain changes to Answers.com that have ledus to believe that adding content may, once again, be a viable way to growtraffic, however,  there is no assurancewe will succeed in achieving renewed growth for Answers.com.

 

WikiAnswers.com advertisingrevenue for the three months ended June 30, 2008 increased $1,323 thousandcompared to the three months ended June 30, 2007, due to increases in traffic,and to a lesser extent, due to improvement in RPM.  WikiAnswers.com average daily page views inthe three months ended June 30, 2008 were 2,318,000, an increase of 427%compared to the average daily page views of 440,000 in the three months endedJune 30, 2007. We believe that the dramatic growth that WikiAnswers hasexperienced since we acquired it, in November 2006, is primarily due to theunique dynamics of the site. As our database of questions and answers grows, wedraw new traffic, primarily from SEO, which in turn results in the creation ofnew questions and answers, or new content, which in turn drives additionalgrowth. This is a self-perpetuating growth model. The WikiAnswers.com RPMduring those periods rose from $4.42 to $7.11, primarily due to the inclusionof WikiAnswers under our Google Services Agreement, replacing the standard Adsenseagreement that was entered into prior to our acquisition of WikiAnswers.

 

WikiAnswers.com advertisingrevenue for the six months ended June 30, 2008 increased $2,392 thousandcompared to the six months ended June 30, 2007, due to increases in traffic,and to a lesser extent, due to improvement in RPM.  WikiAnswers.com average daily page views inthe six months ended June 30, 2008 were 2,101,000, an increase of 473% comparedto the average daily page views of 367,000 in the six months ended June 30,2007. We believe that the dramatic growth that WikiAnswers has experiencedsince we acquired it, in November 2006, is primarily due to the unique dynamicsof the site. As our database of questions and answers grows, we draw newtraffic, primarily from SEO, which in turn results in the creation of newquestions and answers, or new content, which in turn drives additional growth.This is a self-perpetuating growth model. The WikiAnswers.com RPM during thoseperiods rose from $4.41 to $7.01, primarily due to the inclusion of WikiAnswersunder our Google Services Agreement, replacing the standard Adsense agreementthat was entered into prior to our acquisition of WikiAnswers.

 

Approximately $200 thousandand $64 thousand of our advertising revenue in the three months ended June 30,2008 and 2007, respectively, resulted from the efforts of our direct ad salesforce. Approximately $431 thousand and $159 thousand of our advertising revenuein the six months ended June 30, 2008 and 2007, respectively, resulted from theefforts of our direct ad sales force.  Inan effort to improve monetization, in the fourth quarter of 2006, we beganmarketing directly to advertisers and generating additional advertisingrevenue. However, at the end of the second quarter of 2008 we decided toabandon that effort, and by the end of the third quarter of 2008, the directsales staff will be leaving the Company.

 

Subscription revenue in the sixmonths ended June 30, 2007 of $425 thousand resulted from the recognition ofrevenue from the sale of lifetime subscriptions to our GuruNet service prior toDecember 2003. As of December 31, 2006, we had approximately $425 thousandof deferred revenue relating to these subscriptions. Prior to 2007, we did notrecognize any revenue from the lifetime subscriptions to our GuruNet servicebecause the subscriptions had no defined term. On February 2, 2007, inaccordance with our rights under the agreements we entered into with suchsubscribers, we terminated the GuruNet service and thereby extinguished ourservice obligations to our subscribers. As a result, we recognized the entire$425 thousand previously deferred, as revenue, in the first quarter of 2007. Afterthe launch of Answers.com in January 2005, we ceased offering new subscriptionsto GuruNet.

 

***Revenue Trends by Web Property***

 

The following tableillustrates the historical trends of our two Web properties’ traffic, revenuesand RPMs, by quarter, beginning the first quarter of 2007:

 

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| ** **                             | ** ** | **2007**      | ** ** | **2008**      | ** ** |
|----------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                             | ** ** | **Q1**        | ** ** | **Q2**        | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Q1** | ** ** | **Q2** | ** ** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |
| **Ad Revenue ($ - in thousands)** |       |          |       |          |       |   |   |   |   |   |   |   |   |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |
| Answers.com                            |       | 2,768         |       | 2,551         |       | 1,861 |   | 2,270 |   | 1,828 |   | 1,485 |   |
| WikiAnswers                            |       | 116           |       | 177           |       | 304 |   | 704 |   | 1,185 |   | 1,500 |   |
| **Total**                              | ** ** | **2,884**     | ** ** | **2,728**     | ** ** | **2,165** | ** ** | **2,974** | ** ** | **3,013** | ** ** | **2,985** | ** ** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |
| Answers.com                            |       | 96            | %          | 94            | %          | 86 | % | 76 | % | 61 | % | 50 | % |
| WikiAnswers                            |       | 4             | %          | 6             | %          | 14 | % | 24 | % | 39 | % | 50 | % |
| **Total**                              | ** ** | **100**       | **%**      | **100**       | **%**      | **100** | **%** | **100** | **%** | **100** | **%** | **100** | **%** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |
| **Traffic**                            |       |          |       |          |       |   |   |   |   |   |   |   |   |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |
| Answers.com                            |       | 4,945,000     |       | 4,441,000     |       | 3,726,000 |   | 3,447,000 |   | 3,225,000 |   | 2,641,000 |   |
| WikiAnswers                            |       | 293,000       |       | 440,000       |       | 639,000 |   | 1,152,000 |   | 1,885,000 |   | 2,318,000 |   |
| **Total**                              | ** ** | **5,238,000** | ** ** | **4,881,000** | ** ** | **3,915,000** | ** ** | **4,599,000** | ** ** | **5,110,000** | ** ** | **4,959,000** | ** ** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |
| Answers.com                            |       | 94            | %          | 91            | %          | 84 | % | 75 | % | 63 | % | 53 | % |
| WikiAnswers                            |       | 6             | %          | 9             | %          | 16 | % | 25 | % | 37 | % | 47 | % |
| **Total**                              | ** ** | **100**       | **%**      | **100**       | **%**      | **100** | **%** | **100** | **%** | **100** | **%** | **100** | **%** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |
| **RPM**                                |       |          |       |          |       |   |   |   |   |   |   |   |   |
| Answers.com                            |       | $             | 6.22       |          | $          | 6.31 |   | $ | 6.17 |   | $ | 7.16 |   | $ | 6.23 |   | $ | 6.18 |   |
| WikiAnswers                            |       | $             | 4.40       |          | $          | 4.42 |   | $ | 5.17 |   | $ | 6.64 |   | $ | 6.95 |   | $ | 7.11 |   |
|                                   |       |          |       |          |       |   |   |   |   |   |   |   |   |

 

Since we purchasedWikiAnswers in November 2006, the website has grown significantly, eachquarter, both in terms of traffic and revenue. Conversely, in 2007, andespecially beginning the third  quarterof 2007, when we experienced a drop in our traffic due to a search engine algorithmadjustment by Google, Answers.com’s quarterly traffic and revenue has generallydeclined. In 2008, we expect that Answers.com traffic will decline, while weexpect WikiAnswers traffic to continue to grow significantly.

 

**Costs and Expenses**

 

***Cost of Revenue***

 
| ** **      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **      | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **      | ** ** | **($ - in thousands)**               | ** ** | **($ - in thousands)**             | ** ** |
|            |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Cost of revenue |       | 1,416                                               |       | 1,320                                             |       | 96 |   | 2,809 |   | 2,464 |   | 345 |   |

 

Cost of revenue increased $96thousand, or 7%, to $1,416, in the three months ended June 30, 2008 from $1,320in the three months ended June 30, 2007. The increase in cost of revenue wasdue primarily to increases in data center costs of $78 thousand, includingdepreciation of information technology assets, increases in compensation costsof $58 thousand as a result of staffing additions, salary increases and theweak U.S. dollar as compared to the Israel shekel, increases in trafficacquisition costs of $9 thousand, increased travel of $20 thousand, increasesin overhead of $19 thousand, and increases in ad serving fees of $9 thousand.The aforesaid increases were partially offset by a reduction in amortizationexpense. Amortization expense results from intangible assets we purchased inconnection with the Brainboost acquisition that took place in December 2005 andthe WikiAnswers acquisition that took place in November 2006. The amortizationof the Brainboost technology decreased by $89 thousand, since we wrote it offon May 25, 2008. The amortization of the intangible assets related toWikiAnswers decreased by $15 thousand in the three months ended June 30, 2008,since some of the assets we purchased are now fully amortized.

 

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Costof revenue increased $345 thousand, or 14%, to $2,809, in the six months endedJune 30, 2008 from $2,464 in the six months ended June 30, 2008. The increasein cost of revenue was due primarily to increases in data center costs of $156thousand, including depreciation of information technology assets, increases incompensation costs of $129 thousand as a result of staffing additions, salaryincreases and the weak U.S. dollar as compared to the Israel shekel, increasesin traffic acquisition costs of $22 thousand, increases in ad serving fees of $23thousand, increases in travel of $22 thousand, increases in content licensingcosts of $13 thousand, increases in overhead of $23 thousand, and increases infees we pay to Google for web search of $10 thousand. Additionally, recruitmentfees in the six months ended June 30, 2008 were $29 thousand, where no suchexpense was incurred in the six months ended June 30, 2007. The aforesaidincreases were partially offset by a reduction in amortization expense.Amortization expense results from intangible assets we purchased in connectionwith the Brainboost acquisition that took place in December 2005 and theWikiAnswers acquisition that took place in November 2006. The amortization ofthe Brainboost technology decreased by $89 thousand, as it was written off onMay 25, 2008. The amortization of the intangible assets related to WikiAnswersdecreased by $31 thousand in the six months ended June 30, 2008, since some ofthe assets we purchased are now fully amortized.

 

***Research and Development Expenses***

*** ***
| ** **                | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                | ** ** | **($ - in thousands)**               | ** ** | **($ - in thousands)**             | ** ** |
|                      |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Research and  development |       | 929                                                 |       | 748                                               |       | 181 |   | 1,804 |   | 1,469 |   | 335 |   |

 

Research and developmentexpenses increased $181 thousand, or 24%, to $929 thousand in the three monthsended June 30, 2008 from $748 thousand in the three months ended June 30, 2007.The increase in research and development expenses was due primarily to anincrease of $133 thousand in compensation, as a result of staffing additions,salary increases and the weak U.S. dollar as compared to the Israel shekel, andincreases in overhead of $34 thousand, also impacted by the weak U.S. dollar ascompared to the Israel shekel.

 

Research and developmentexpenses increased $335 thousand, or 23%, to $1,804 thousand in the six monthsended June 30, 2008 from $1,469 thousand in the six months ended June 30, 2007.The increase in research and development expenses was due primarily to anincrease of $304 thousand in compensation-related expenses as a result ofstaffing additions, salary increases and the weak U.S. dollar as compared tothe Israel shekel, and increases in overhead of $49 thousand, also impacted bythe weak U.S. dollar as compared to the Israel shekel. Those increases werepartially offset by a reduction of $22 thousand in outside consulting services.

 

***Sales and Marketing Expenses***

 
| ** **          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **          | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **          | ** ** | **($ - in thousands)**               | ** ** | **($ - in thousands)**             | ** ** |
|                |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Sales and marketing |       | 933                                                 |       | 1,072                                             |       | (139 | ) | 1,695 |   | 2,054 |   | (359 | ) |

 

Sales and marketing expensesdecreased $139 thousand or 13%, to $933 thousand during the three months ended June30, 2008 from $1,072 thousand during the three months ended June 30, 2007. Thedecrease in sales and marketing expenses is due primarily to a decrease incompensation related expenses, excluding stock-based compensation, of $47thousand, and a decrease in stock-based compensation of $176 thousand. Thesedecreases resulted mostly from the termination of employment of our ChiefRevenue Officer in the third quarter of 2007. The aforesaid decreases werepartially offset by a charge of $90 thousand, in the second quarter of 2008, toaccount for the estimated cost of terminating certain service contractsrelating to our abandoned direct ad sales efforts.

 

Sales and marketing expensesdecreased $359 thousand or 17%, to $1,695 thousand during the six months endedJune 30, 2008 from $2,054 thousand during the six months ended June 30, 2007.The decrease in sales and marketing expenses is due primarily to a decrease in compensationrelated expenses, excluding stock-based compensation, of $98 thousand, and adecrease in stock-based compensation of $311 thousand. These decreases resultedmostly from the termination of employment of our Chief Revenue Officer in thethird quarter of 2007. The aforesaid decreases were partially offset by acharge of $90 thousand, in the second quarter of 2008, to account for theestimated cost of terminating certain service contracts relating to ourabandoned direct ad sales efforts.

 

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***General and Administrative Expenses***

 
| ** **                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **($ - in thousands)**               | ** ** | **($ - in thousands)**             | ** ** |
|                       |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| General and administrative |       | 1,198                                               |       | 1,019                                             |       | 179 |   | 2,329 |   | 1,945 |   | 384 |   |

 

General and administrativeexpenses increased $179 thousand, or 18%, to $1,198 thousand during the threemonths ended June 30, 2008 from $1,019 thousand during the three monthsended June 30, 2007. The increase in general and administrative expenseswas due primarily to increases in compensation costs of $121 thousand as aresult of staffing additions, salary increases and the weak U.S. dollar ascompared to the Israel shekel, increases in accounting fees of $43 thousand, asa result of issues related to the Redpoint transaction, increases in overheadof $32 thousand, mainly due to the weak U.S. dollar as compared to the Israelshekel , and the addition of investor relations services for $24 thousand, anexpense we did not incur during the same period in 2007.  The aforesaid increases were offset, to someextent, by a reduction in legal expenses of $24 thousand and a reduction intravel of $28 thousand.

 

General and administrativeexpenses increased $384 thousand, or 20%, to $2,329 thousand during the sixmonths ended June 30, 2008 from $1,945 thousand during the six monthsended June 30, 2007. The increase in general and administrative expenses wasdue primarily to increases in compensation costs of $255 thousand as a resultof staffing additions, salary increases and the weak U.S. dollar as compared tothe Israel shekel, increases in accounting fees of $80 thousand, mostly due toissues related to the Redpoint transaction, increases in overhead of $22thousand, mainly due to the weak U.S. dollar, and  the addition of investor relations servicesfor $24 thousand, an expense we did not incur during the same period in2007.  The aforesaid increases wereoffset, to some extent, by a reduction in legal expenses of $19 thousand and areduction in travel of $18 thousand.

 

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

*** ***
| ** **                                | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                                | ** ** | **($ - in thousands)**               | ** ** | **($ - in thousands)**             | ** ** |
|                                      |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Write-off of the Brainboost Answer Engine |       | 3,138                                               |       | —                                            |       | 3,138 |   | 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 three and six months ended June 30, 2008.

 

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

*** ***
| ** **                                                                                                               | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 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 six months ended June 30,2008, we recorded a charge of $2,543 thousand for various costs and fees weincurred in connection with the terminated acquisition of Lexico and thefollow-on offering of securities.

 

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***Interest Income, Net***

 
| ** **           | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **           | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **           | ** ** | **($ - in thousands)**               | ** ** | **($ - in thousands)**             | ** ** |
|                 |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Interest income, net |       | 18                                                  |       | 112                                               |       | (94 | ) | 73 |   | 212 |   | (139 | ) |

 

Interest income, net decreased$94 thousand, or 84%, to $18 thousand for the three months ended June 30,2008 from $112 thousand for the three months ended June 30, 2007. Thedecrease in interest income resulted from lower average cash and investmentsecurities balances, and lower short-term interest rates, during the threemonths ended June 30, 2008, as compared to the three months ended June 30,2007. Additionally, certain transaction costs that we incurred in connectionwith the Redpoint Financing have been deferred and are being amortized tointerest expense over one year. During the three months ended June 30,2008, $15 thousand of such deferred costs have been amortized and charged tointerest expense.

 

Interest income, netdecreased $139 thousand, or 66%, to $73 thousand for the six months ended June 30,2008 from $212 thousand for the six months ended June 30, 2007. Thedecrease in interest income resulted from lower average cash and investmentsecurities balances, and lower short-term interest rates, during the six monthsended June 30, 2008, as compared to the six months ended June 30,2007. Additionally, certain transaction costs that we incurred in connectionwith the Redpoint Financing have been deferred and are being amortized tointerest expense over one year. During the six months ended June 30, 2008,$15 thousand of such deferred costs have been amortized and charged to interestexpense.

 

***Other Expenses, Net***

 
| ** **         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **         | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **Change** | ** ** | **2008** | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **         | ** ** | **($ - in thousands)**               | ** ** | **($ - in thousands)**             | ** ** |
|               |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Other expense, net |       | (11                                                 | )          | 4                                                 |       | (15 | ) | (49 | ) | (12 | ) | (37 | ) |

 

Other income (expense), net,during the three months ended June 30, 2008 was an expense of $11thousand, compared to other income of $4 thousand in the three months ended June 30,2008, a net change of $15 thousand. Other expenses in both periods resultedfrom foreign currency exchange net gains and losses.

 

Other expense, net increased$37 thousand, or 308%, to $49 thousand for the six months ended June 30,2008 from $12 thousand for the six months ended June 30, 2007. Otherexpenses in both periods resulted from foreign currency exchange net losses.

* *

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

 

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. Weare currently evaluating what impact, if any, the recent Redpoint Financingwill have on our ability to use our NOLs. Our Israeli subsidiary has capitalloss carryforwards of approximately $800 thousand that can be applied tofuture capital gains for an unlimited period of time under current tax rules.

 

**Liquidityand Capital Resources**

** **

Ourprincipal sources of liquidity are cash and cash equivalents, which were$10,187 thousand as of June 30, 2008. In the six months ended June 30,2008, our cash used in operations was $2,335 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.

 

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| ** **                                           | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| ** **                                           | ** ** | **($ - in thousands)**             | ** ** |
|                                                 |       |                                              |       |   |   |
| Net cash used in operating activities                |       | (2,335                                            | )          | (8 | ) |
| Net cash provided by (used in) investing  activities |       | 308                                               |       | (546 | ) |
| Net cash provided by financing activities            |       | 5,369                                             |       | 145 |   |

*** ***

***Operating Activities***

 

Despite a net loss of $8,286thousand in the six months ended June 30, 2008, net cash used inoperations was $2,335 thousand. The adjustments to reconcile the two amounts,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, $921 thousand of operating expenses that were theresult of non-cash, stock-based compensation to employees and directors,depreciation and amortization of $831 thousand, and the write-off of amountsthat were paid in prior periods relating to the terminated Lexico acquisitionand abandoned follow-on offering, of $663 thousand.

 

***Investing Activities***

 

Net cash provided by (usedin) investing activities in the six months ended June 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 for capitalexpenditures, as delineated in our Consolidated Statement of Cash Flows.

 

***Financing Activities***

 

Net cash flow from financingactivities in the six months ended June 30, 2008 was almost entirely fromthe Redpoint Financing. Cash flow from financing activities in the six monthsended June 30, 2007 resulted from the exercise of stock options.

 

***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 a warrant to purchase units, exercisable at anytime until June 16, 2009, for up to $7 million of Series BConvertible Preferred Stock and Series B Purchase Warrants.   The Series A Preferred Stock contains aredemption provision which allows the holder of a majority of the Series APreferred Stock to request redemption, at any time on or after June 16,2014, of all or any part of the outstanding Series A Preferred Stock.  If issued, the Series B Preferred Stockwould have a similar redemption provision.

 

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 expensed 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 in 2008.However, our business strategy includes growth through additional businesscombinations and licensing or acquiring products and technologies complementaryto our business, which could require use of a significant amount of ouravailable cash. We may therefore need to raise additional capital throughfuture debt or equity financing to finance such initiatives. However, we cannotbe certain that additional financing will be available on acceptable terms, orat all. To the extent that we raise additional funds by issuing equitysecurities, our stockholders may experience significant dilution.

 

**ContractualObligations and Commitments**

 

As of June 30, 2008, wehad the following known contractual obligations and commitments ($ - inthousands):

 
| ** **                                       | ** ** | **Purchase  Contracts** | ** ** | **Capital  Leases** | ** ** | **Operating  Leases** | ** ** | **Total(1)** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|---------------------|------------|-----------------------|------------|--------------|------------|
|                                             |       |                    |       |                |       |                  |       |         |       |
| 2008 (six months ending  December 31, 2008) |       | 227                     |       | 43                  |       | 224                   |       | 494          |       |
| 2009                                             |       | 300                     |       | 86                  |       | 403                   |       | 789          |       |
| 2010                                             |       | 45                      |       | 85                  |       | 241                   |       | 371          |       |
| 2011                                             |       | —                  |       | 31                  |       | 1                     |       | 32           |       |
|                                             |       |                    |       |                |       |                  |       |         |       |
|                                             |       | 572                     |       | 245                 |       | 869                   |       | 1,686        |       |

 

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(1)           The above table does not includeunrecognized tax benefits of $328 thousand.

 

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** **

**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 13% during the six months ending June 30, 2008. Ifthe value of the U.S. dollar further weakens against the value of NIS,there will be a negative impact on our results of operations. In addition, tothe extent we hold cash and cash equivalents that are denominated in currenciesother than the U.S. dollar, we are subject to the risk of exchange ratefluctuations. We use various hedging tools, including forward contracts andoptions, to lessen the effect of currency fluctuations on our income.

 

*OtherMarket Risk.*  As of June 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 andsix months ended June 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 identifiabledefinite and indefinite-lived acquired intangible assets in accordance withSFAS No. 142, “Goodwill and Other Intangible Assets,” orSFAS 142. Additionally, we review our long-lived assets for recoverabilityin accordance with SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets,” or SFAS 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 the assetsexceeds the fair value of the assets. While we use available information toprepare our estimates and to perform impairment evaluations, the completion ofannual 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.

 

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*** ***

***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 estimating expectedforfeitures, including historical experience. Actual results may differsubstantially 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 themarket value of our stock, stock price volatility or the estimated time optionand warrant grants will be outstanding before they are ultimately exercised,the related stock based compensation expense and our net loss and net loss pershare amounts could have been significantly different, in the three months andsix months ended June, 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.

 

***Redpoint Financing***

*** ***

We estimated the fair value of the three components embodied in ouragreement with Redpoint:  (i) Series AConvertible Preferred Stock, (ii) Series A Purchase Warrants and (iii) thewarrant to acquire Series B Convertible Preferred Stock and Series BPurchase Warrants. 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.

 

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**RecentlyIssued Accounting Pronouncements**

 

In March 2008, theFASB issued 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 of credit-risk-relatedcontingent features in their hedged positions. SFAS 161 is effective forfinancial statements issued for fiscal years beginning after November 15,2008 and interim periods within those years. We do not expect the adoption ofSFAS 161 to have a material 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 arecurrently evaluating the potential impact of the adoption of FSP APB 14-1 on our consolidatedfinancial statements.

* *

**QuarterlyResults**

 

The following table setsforth our historical unaudited quarterly consolidated statement of operationsdata for 2007 and the first two quarters of 2008. You should read thisinformation together with our unaudited consolidated financial statements andthe related notes appearing elsewhere in our filings. The results of historicalperiods are not necessarily indicative of the results of operations for a fullyear or any future period.

 
| ** **                                                                                                               | ** ** | **Quarter Ended**                                                               | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                                                                                                               | ** ** | **Mar. 31,  2007**                                                              | ** ** | **Jun. 30,  2007** | ** ** | **Sep. 30,  2007** | ** ** | **Dec. 31,  2007** | ** ** | **Mar. 31,  2008** | ** ** | **Jun. 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 |   |
| Answers services licensing                                                                                               |       | 77                                                                                   |       | 82 |   | 43 |   | 17 |   | 18 |   | 18 |   |
| Subscriptions                                                                                                            |       | 425                                                                                  |       | — |   | — |   | — |   | — |   | — |   |
|                                                                                                                     |       | 3,386                                                                                |       | 2,810 |   | 2,208 |   | 2,991 |   | 3,031 |   | 3,003 |   |
| Costs and expenses:                                                                                                      |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Cost of revenue                                                                                                          |       | 1,144                                                                                |       | 1,320 |   | 1,179 |   | 1,247 |   | 1,393 |   | 1,416 |   |
| Research and development                                                                                                 |       | 722                                                                                  |       | 748 |   | 769 |   | 739 |   | 875 |   | 929 |   |
| Sales and marketing                                                                                                      |       | 982                                                                                  |       | 1,072 |   | 1,221 |   | 676 |   | 762 |   | 933 |   |
| General and administrative                                                                                               |       | 926                                                                                  |       | 1,019 |   | 1,058 |   | 1,017 |   | 1,131 |   | 1,198 |   |
| Write-off of  the Brainboost Answers Engine                                                                              |       | —                                                                               |       | — |   | — |   | — |   | — |   | 3,138 |   |
| Termination  fees and write-off of costs 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 |   |
|                                                                                                                     |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Operating loss                                                                                                           |       | (388                                                                                 | )          | (1,349 | ) | (2,019 | ) | (688 | ) | (3,673 | ) | (4,611 | ) |
| Interest income, net                                                                                                     |       | 100                                                                                  |       | 112 |   | 88 |   | 85 |   | 55 |   | 18 |   |
| Other income (expense), net                                                                                              |       | (15                                                                                  | )          | 4 |   | — |   | — |   | (38 | ) | (11 | ) |
|                                                                                                                     |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loss before income taxes                                                                                                 |       | (303                                                                                 | )          | (1,233 | ) | (1,931 | ) | (603 | ) | (3,655 | ) | (4,604 | ) |
| Income taxes(1)                                                                                                          |       | —                                                                               |       | (14 | ) | (19 | ) | (15 | ) | (11 | ) | (15 | ) |
|                                                                                                                     |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                                                                 |       | $                                                                                    | (303       | ) | $ | 1,247 | ) | $ | (1,950 | ) | $ | (618 | ) | $ | (3,667 | ) | $ | (4,619 | ) |
|                                                                                                                     |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Other Data:                                                                                                              |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Adjusted EBITDA(1)                                                                                                       |       | $                                                                                    | 160        |   | $ | (306 | ) | $ | (727 | ) | $ | 180 |   | $ | (181 | ) | $ | (670 | ) |
| Answers.com page views                                                                                              |       | 4,945,000                                                                            |       | 4,441,000 |   | 3,726,000 |   | 3,447,000 |   | 3,225,000 |   | 2,641,000 |   |
| WikiAnswers page views                                                                                              |       | 293,000                                                                              |       | 440,000 |   | 639,000 |   | 1,152,000 |   | 1,885,000 |   | 2,318,000 |   |
| Answers.com RPM                                                                                                          |       | $                                                                                    | 6.22       |   | $ | 6.31 |   | $ | 6.17 |   | $ | 7.16 |   | $ | 6.23 |   | $ | 6.18 |   |
| WikiAnswers RPM                                                                                                          |       | $                                                                                    | 4.40       |   | $ | 4.42 |   | $ | 5.17 |   | $ | 6.64 |   | $ | 6.95 |   | $ | 7.11 |   |

 

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| (1)    | We define Adjusted EBITDA  as net earnings before interest, 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), 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: |

 

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·             Adjusted EBITDA disregards amortization ofintangible assets and other specified costs resulting from acquisitions.Specifically, we exclude (a) amortization of acquired technology from ouracquisition of Brainboost Technology, LLC, or Brainboost, developer of theBrainboost Answer Engine; (b) the Q2 2008 write-off of the BrainboostAnswer Engine; (c) compensation expense resulting from the portion of thestock component of the Brainboost purchase price that was deemed compensationexpense; (d) penalty payments to the sellers of Brainboost resulting fromfailure to timely register the common stock they received in connection withthe acquisition;  (e) amortizationof intangible assets relating to our acquisition of WikiAnswers; and (f) variouscosts and fees we incurred in connection with the terminated acquisition ofLexico and the abandoned follow-on offering of securities. We believe thatexcluding these expenses is helpful to investors, due to the fact that theyrelate to prior acquisitions and are not necessarily indicative of futureoperating expenses. While we exclude these expenses from Adjusted EBITDA we donot exclude the revenue derived from the acquisitions. The revenue attributableto WikiAnswers.com for the six months ended June 30, 2008 and the yearsended December 31, 2007 and 2006 was $2,685 thousand, $1,302 thousand and$62 thousand, respectively. The revenue attributable to our acquisition of theBrainboost technology is not quantifiable due to the nature of its integration.

 

·             We believe that, because of the variety ofequity awards used by companies, the varying methodologies for determiningstock-based compensation expense, and the subjective assumptions involved inthose determinations, excluding stock-based compensation from Adjusted EBITDAenhances the ability of management and investors to compare financial resultsover multiple periods.

 

·             Prior to December 2003, we sold lifetimesubscriptions to our GuruNet service, generally for $40 per subscription. In December 2003,we decided to alter our pricing model and moved to an annual subscriptionmodel, for which we generally charged our subscribers $30 per year. We have notsold subscriptions since our launch of Answers.com in January 2005. In February 2007,we terminated the GuruNet service and recognized $425 thousand of deferredrevenue as revenue during the quarter ended March 31, 2007. We believethat the recognition of the $425 thousand of revenue is a one-time, non-cashevent 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 ameasure of liquidity or financial performance under generally acceptedaccounting principles and should not be considered in isolation from, or as asubstitute for, a measure of financial performance prepared in accordance withGAAP. Investors are cautioned of inherent limitations associated with the use of Adjusted EBITDA as ananalytical tool. Some of these limitations are:

 

·             Non-GAAP financial measures are not based ona comprehensive set of accounting rules or principles;

 

·             Many of the adjustments to Adjusted EBITDAreflect the exclusion of items that are recurring and will be reflected in ourfinancial results for the foreseeable future;

 

·             Other companies, including other companies inour industry, may calculate Adjusted EBITDA differently than us, thus limitingits usefulness as a comparative tool;

 

·             Adjusted EBITDA does not reflect the periodiccosts of certain tangible and intangible assets used in generating revenues inour business;

 

·             Adjusted EBITDA does not reflect changes inour cash and investment securities and the results of our investments;

 

·             Adjusted EBITDA excludes taxes, which is anintegral cost to most businesses; and

 

·             Because Adjusted EBITDA does not includestock-based compensation, it does not reflect the cost of granting employeesequity awards, a key factor in management’s ability to hire and retainemployees.

 

We compensate for theselimitations by providing specific information in the reconciliation to the GAAPamounts excluded from Adjusted EBITDA. A reconciliation of Adjusted EBITDA tonet loss is 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** | ** ** |
| ** **                                                                                                               | ** ** | **(In thousands)** | ** ** |
| Net loss                                                                                                                 |       | $                       | (303       | ) | $ | (1,247 | ) | $ | (1,950 | ) | $ | (618 | ) | $ | (3,667 | ) | $ | (4,619 | ) |
| Interest income, net                                                                                                     |       | (100                    | )          | (112 | ) | (88 | ) | (85 | ) | (55 | ) | (18 | ) |
| Foreign currency exchange rate differences                                                                               |       | 15                      |       | (4 | ) | — |   | — |   | 38 |   | 11 |   |
| Income taxes                                                                                                             |       | —                  |       | 14 |   | 19 |   | 15 |   | 11 |   | 15 |   |
| Depreciation and amortization                                                                                            |       | 448                     |       | 444 |   | 464 |   | 442 |   | 448 |   | 383 |   |
| Stock-based compensation                                                                                                 |       | 525                     |       | 599 |   | 574 |   | 426 |   | 501 |   | 420 |   |
| Write-off of  the Brainboost Answers Engine                                                                              |       | —                  |       | — |   | — |   | — |   | — |   | 3,138 |   |
| Termination  fees and write-off of costs relating to the terminated Lexico acquisition and  abandoned follow-on offering |       | —                  |       | — |   | — |   | — |   | 2,543 |   | — |   |
| Cost related to August 2007 layoffs                                                                                 |       | —                  |       | — |   | 254 |   | — |   | — |   | — |   |
| Subscription revenue from lifetime  subscriptions                                                                        |       | (425                    | )(1)       | — |   | — |   | — |   | — |   | — |   |
| Adjusted EBITDA                                                                                                          |       | $                       | 160        |   | $ | (306 | ) | $ | (727 | ) | $ | 180 |   | $ | (181 | ) | $ | (670 | ) |

 

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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 these investments,we believe that there is no material exposure to interest rate risk arisingfrom our investments. Based on our investment policy, such instruments arehighly rated by rating agencies and therefore we believe that there is nomaterial 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 June 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 June 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 June 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 $4.1 million and $8.6 millionfor the years ended December 31, 2007 and 2006, respectively. As of December 31,2007, we had an accumulated deficit of approximately $59 million. We cannotassure you that we will be able to achieve net income on a quarterly or annualbasis. If our revenues do not increase, or if our operating expenses exceedexpectations or cannot be reduced, we will continue to incur substantiallosses, which would materially adversely affect our business and financialresults.

 

***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 topic pages often appear as one of the top links on the pages returnedby search engines in response to users’ search queries. As a result, we relyheavily on search engines for a substantial portion of the users visiting ourWeb properties. According to our internal estimates traffic to our Webproperties originating from search engines during the second quarter of 2008,excluding Google-directed definition link traffic, was approximately 73% of theoverall traffic to our Web properties, the majority of which originated fromGoogle and, to a lesser but still significant extent, Yahoo!. Traffic toWikiAnswers from search engines during the same period was even moresignificant, amounting to approximately 90% of its overall traffic. If ourtraffic from search engines declines for any reason, we would suffer asignificant decline in overall traffic and revenue. For example, in July 2007,a search 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 successfully reactto these actions in the future and recover the 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 our Web properties from the search engines, could cause asignificant decrease in traffic and revenues, which could adversely affect ourbusiness and financial results.

 

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

 

Asignificant percentage of our direct traffic is directed to Answers.com by thedefinition link appearing on Google’s website result pages. As an additionalresult of this arrangement, a significant number of secondary users visit Webproperties via the definition link and perform additional searches. We refer tothese users as secondary traffic. The definition link traffic is the result ofa unilateral decision by Google to link certain definitions to Answers.com, andnot any contractual relationship. Google may change these links at any time, inits sole discretion. According to our internal estimates, for the second quarterof 2008, the primary and secondary traffic from the Google definition linkaccounted for approximately 7% of the traffic to our Web properties. If Googlestops directing traffic to Answers.com through its definition link, we wouldexperience a significant reduction in our direct traffic and the correspondingad revenues, which would adversely affect our business 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.***

 

Ourbusiness is dependent on the GSA, under which we obtain most of theadvertisements displayed on our Web properties and earn most of our adrevenues. Google may terminate the GSA with no advance notice if we:

 

·            take certain prohibited actions including, among other things:

 

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|                                         | ·                                                                                                                     | editing  or modifying the order of search results,                                                                                              |
|----------------------------------------------|----------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|                                         |                                                                                                                       |                                                                                                                                            |
|                                         | ·                                                                                                                     | redirecting  end users, producing or distributing any software which prevents the display  of ads by Google,                                    |
|                                         |                                                                                                                       |                                                                                                                                            |
|                                         | ·                                                                                                                     | modifying,  adapting or otherwise attempting to obtain source code from Google  technology, content, software and documentation or         |
|                                         |                                                                                                                       |                                                                                                                                            |
|                                         | ·                                                                                                                     | engaging  in any action or practice that reflects poorly on Google or otherwise  disparaging 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 brand features 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 such  breaches.                                |

 

The GSA is scheduled to expire on January 31,2010, unless renewed upon mutual written consent.

 

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 receiving equally favorable terms as those provided in 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.

 

***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. We estimate that in the secondhalf of 2008, WikiAnswers will exceed Answers.com in both traffic and revenue.WikiAnswers is experiencing a growth phenomenon that we refer to as a “networkeffect”.  The site’s growth facilitates further growth. As a result,we are spending increasing amounts of money and devoting greater resources tothe development of WikiAnswers. If, for whatever reason, WikiAnswers fails toperform as well as we anticipate, and the growth we are experiencing falters orceases, our business and financial results could be 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 increasing 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 more frequently withour WikiAnswers Web property and to increase the amount of user generatedcontent they provide, our ability to attract new users to the Web property,increase the number of registered users loyal to the community and attractadvertisers to WikiAnswers will be diminished and adversely affected. As aresult, our business and financial results will suffer, and we will not be ableto grow our business as planned.

 

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*** ***

***If we are unable to improve andmaintain 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 closely monitorthe content being contributed by users and constantly be on the alert for andfilter out content that does not add value, or even worse, damages the userexperience. If we fail to maintain and improve the quality of the Web property’scontent, the appeal of WikiAnswers to users may diminish and the growth of theWeb property may be negatively affected, which in turn could cause ourfinancial results to suffer.

 

***If we are unable to attract andretain dedicated supervisors for WikiAnswers for the******administration of the Web property and the encouragement ofthe community’s******expansion, our plans for growing WikiAnswers may fail and our resultsof operations******may be adversely affected.***

 

Muchof the effort of administering WikiAnswers, monitoring its activity andensuring its steady growth and development is borne by a large group ofexternal supervisors, the vast majority of whom are not employed by us and notcompensated for their efforts. The supervisors are in charge of monitoringquestions and answers in specific categories in an effort to ensure questionsare being answered timely, prevent vandalism, improve consistency and encouragehigh-quality contributions. As of June 30, 2008, the community enjoyed thebenefit of well over 300 such supervisors. The success of WikiAnswers isdependant, to a certain extent, on the continued attention of these supervisorsto WikiAnswers. If we are not able to attract and maintain enough supervisors,the WikiAnswers Web property will suffer and the Web property will become lessattractive to users, which in turn will adversely affect the site’s growth andour 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 short operating historyand a relatively new business model in an emerging******and rapidly evolving market. This makes it difficult toevaluate our future prospects******and may increase the risks that we will not continue tobe 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 first derived advertising revenue in thefirst quarter of 2005, and we have only a short operating history with our CPCand CPM advertising model. As a result, we have very little operating historyto aid in assessing our future prospects. Also, we derive nearly all of ourrevenues from online advertising, which is an immature industry that hasundergone rapid and dramatic changes in its short history. We will encounterrisks and difficulties as a growing company in a new and rapidly evolvingmarket. We may not be able to successfully address these risks anddifficulties, which could materially harm 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;

 

·            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. Ifadequate funds are not available or are not available on acceptable terms, whenwe desire them, our ability to fund our operations, take advantage ofunanticipated opportunities, develop or enhance our services, or otherwiserespond to competitive pressures would be significantly limited.

 

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***We generate our revenue almostentirely from advertising so uncertainties in the******Internet advertising market and our failure to increaseadvertising inventory on our******Web properties could adversely affect our ad revenues.***

 

Althoughworldwide online advertising spending is growing steadily, it represents only asmall percentage of total advertising expenditures. Our advertisers cangenerally terminate their contracts with us at any time. Advertisers will notcontinue to do business with us if their investment in Internet advertisingwith us does not generate sales leads, and ultimately customers, or if we donot deliver their advertisements in an appropriate and effective manner. If theInternet does not continue to be as widely accepted as a medium for advertisingand the rate of advertising on the Internet increase, our ability to generateincreased revenues could be adversely affected. We believe that growth in ourad revenues will also depend on our ability to increase the number of pages onour Web properties to provide more advertising inventory. If we fail toincrease our advertising inventory at a sufficient rate, our ad revenues couldgrow more slowly than we expect, which could have an adverse effect on ourfinancial results.

 

***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 and Wikipedia.org. We also compete with industry-specificWeb properties, such as Bankrate.com and WebMD.com, as well as with otherpopular question and answer sites, such as Yahoo! Answers, Askville (owned byAmazon), Yedda (owned by AOL) and Answerbag.com (owned by Demand Media, Inc.).Many of our competitors have longer operating histories, more extensive managementexperience, an employee base with more extensive experience, better geographiccoverage, larger consumer bases, greater brand recognition and significantlygreater financial, marketing and other resource than we do. We expectcompetition to intensify in the future. If our competitors are more successfulthan we are in developing compelling products or attracting and retaining usersor advertisers, then our competitive position and financial results could beadversely affected.

 

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

 

Inaddition to search engine traffic and traffic directed by the Google definitionlink, our traffic also originates from Internet users arriving at our Web propertiesdirectly by typing our website address directly into their Web browser,bookmarking our Web properties, using AnswerTips and visiting sites that directusers to our Web properties. Given the wide availability of free search enginesand reference content sites, we may not be able to retain current Internetusers or attract new Internet users in this direct fashion. If we are unable toretain our direct Internet users or attract new direct Internet users, ourability to generate revenues would be adversely impacted, which could adverselyaffect 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, and we plan to enter into similar arrangements in the future.Although these arrangements have not had a substantial impact on our revenuesto date, they have provided us with third party validation of our productofferings. We believe these arrangements and similar arrangements may result insignificant revenues in the future. These arrangements may be terminated ordiscontinued by the third parties upon varying notice periods. If thesearrangements and similar arrangements impact our revenues substantially in thefuture, then termination of any of these arrangements would result in the lossof ad revenue and adversely affect our financial condition. Further,termination of any of these arrangements could impact our credibility in themarketplace, which could adversely affect our traffic and revenues.

 

***We may not be successful inexpanding our 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.***

 

Weintend to pursue acquisitions, business combinations and joint ventures, whichwe refer to as extraordinary transactions. Our ability to implement thisbusiness strategy depends in large part on our ability to compete successfullywith other entities for acquisition candidates and joint venture partners.Factors affecting our 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.

 

Inaddition, we may not be able to find suitable acquisition candidates and we maynot be able to complete acquisitions on favorable terms, if at all. If we docomplete acquisitions, we may not ultimately strengthen our competitiveposition or achieve our goals, or such acquisitions may be viewed negatively bycustomers, financial markets or investors. In addition, any acquisitions thatwe make could lead to difficulties in integrating personnel and operations fromthe acquired businesses and in retaining and motivating key personnel fromthese businesses. Acquisitions may disrupt our ongoing operations, divertmanagement from day-to-day responsibilities, increase our expenses or adverselyaffect our business, operating results and financial condition. For example, weexperienced such disruption, diversion and increased expenses during the courseof our recent failed attempt to acquire Lexico Publishing Group, LLC. Futureacquisitions may reduce our cash available for operations and other uses andcould result in an increase in amortization expense related to identifiableassets acquired, potentially dilutive issuances of equity securities or theincurrence of debt, which could harm our business, financial condition andoperating results.

 

***If we fail to maintain and enhanceawareness of 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. We also believe that the importance of brand recognition willincrease due to the relatively low barriers to entry in our market. Maintainingand enhancing our Web properties 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 advertisers, which could in turn result inlost revenues and adversely affect our business and financial results.

 

***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. We are heavily dependent on licensedcontent. We cannot guarantee that we will be able to enter into new or renewcurrent or future content agreements on commercially acceptable terms or atall. If we are unable to maintain and enhance our existing relationships withcontent providers or develop new relationships with alternative providers ofcontent, our Answers.com service may become less attractive to Internet users,resulting in decreased traffic to Answers.com, which could have an adverseeffect 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. Delays and interruptions couldfrustrate users and reduce traffic on our Web properties, adversely affectingour operations and growth 

 

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prospects.

 

Wecurrently outsource our Web hosting services to Data Return LLC, recentlyacquired by Terremark Worldwide, Inc. We believe the economicjustification of outsourcing our Web hosting services has diminished, thus, weare in the process of migrating our Web properties to co-location facilitiesand managing the operations with our own staff. This change may betechnologically challenging to implement, take time to test and deploy, causeus to incur substantial costs or data loss, and cause users, advertisers, andaffiliates to experience delays or interruptions in our service. These changes,delays or interruptions in our service could cause users and advertisers tobecome dissatisfied with our service and move to competing providers of onlineservices, reducing the traffic on our Web properties and adversely affectingour business and financial results.

 

***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, sales 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, and the services of keymembers of our research and development team, in particular, would be difficultto replace. If we do not succeed in retaining or replacing our key personnel,we may be unable to execute our business plan and, as a result, our stock pricemay decline.

 

***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 of suchcompensation charges on future operating results because they will be basedupon the fair market value of our common stock and other assumptions at futuredates.

 

***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 

 

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minorsover the Internet to persons under the age of 17 or collecting personalinformation from children under the age of 13. We do not knowingly collect anddisclose personal information from minors. The manner in which COPPA may beinterpreted and enforced cannot yet be determined. Moreover, the applicabilityto the Internet of existing laws governing issues such as property ownership,copyright, defamation, obscenity and personal privacy is uncertain. We may besubject to claims that our content violates such laws, which could damage ourbusiness and cause our stock price to decline.

 

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 claimsis expensive, 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, diversionof 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 use fromtime to time and content we display on our Web properties. For example, a thirdparty may make claims against us over the display of search results triggeredby search terms that include trademark terms. Furthermore, we may be faced withcopyright infringement claims. We have received, and are likely to continue toreceive, “cease and desist” letters demanding that we remove infringing contentfrom our Web properties based on a theory of copyright and trademarkinfringement.

 

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

 
| ·                                                                                                                    | substantial  liability for damages and litigation costs, including attorneys’ fees;                                         |
|---------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                      |                                                                                                                             |
| ·                                                                                                                    | lawsuits  that prevent us from further use of intellectual property and require us to  permanently cease and desist from selling |
| or  marketing products that use the intellectual property;                                                                |
|                                                                                                                      |                                                                                                                             |
| ·                                                                                                                    | licensing  intellectual property from a third party, which could include significant  licensing and royalty fees not presently   |
| paid  by us, adding materially to the our costs of operations;                                                            |
|                                                                                                                      |                                                                                                                             |
| ·                                                                                                                    | developing  new intellectual property, as a non-infringing alternative, that could delay  projects, add materially to our costs  |
| of  operations and be unacceptable to our users, which in turn could adversely  affect our traffic and revenues; and |
|                                                                                                                      |                                                                                                                             |
| ·                                                                                                                    | indemnifying  third parties who have entered into agreements with us with respect to losses  they incurred as a result of the    |
| infringement,  which could include consequential 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 protection maynot be available or cost-effective in every country in which our services aremade available through the Internet. There may be instances where we are notable 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 Web 

 

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propertiesmay be reduced, which could negatively impact our business. In addition,protecting our intellectual property and other proprietary rights is expensiveand diverts critical managerial resources. If any of the foregoing were tooccur, or if we are otherwise unable to protect our intellectual property andproprietary rights, our business and financial results could be adverselyaffected.

 

***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 toincur significant compliance expenses. Compliance with these laws andregulations may also cause us to change or limit our business practices in amanner adverse to our 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 substantially impairthe 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 Global 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 30,000,000 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 July 30, 2008.  Our board of directors hasthe 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. See “Recent Developments” for a description of these transactions and therelated securities.  These issuances may dilute your percentage ownership interest,which will have the effect of reducing your influence on matters on which ourstockholders vote. You may incur additional dilution if holders of stockoptions, whether currently outstanding or subsequently granted, exercise theiroptions or if warrant holders exercise their warrants to purchase shares of ourcommon stock.  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.

 

***We have a limited number of commonshares available for future issuance which could adversely affect our abilityto raise capital or consummate acquisitions.***

 

Weare authorized to issue 30,000,000 shares of common stock. We currentlyhave outstanding 7,859,890 shares of common stock or approximately15,200,000 shares of common stock after giving effect to the assumed exerciseof all outstanding warrants and options and assumed conversion of preferred stock**.** Due to the limited number of authorizedshares available for issuance and because of the significant competition foracquisitions, we may not able to consummate an acquisition until we increasethe number of shares we are authorized to issue. To facilitate the possibilityand flexibility of raising of additional capital or the completion of potentialacquisitions, we will seek shareholder approval to increase the number of ourauthorized shares of common stock. We can provide no assurance that we will succeedin amending our certificate of incorporation to increase the number of sharesof common stock we are authorized to issue.

 

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***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 capital stock. Wecurrently intend to retain any future earnings and do not expect to pay anydividends on our common stock in the foreseeable future.

 

***We may incur penalties for lateregistration of the common stock underlying the Series A ConvertiblePreferred Stock and the Common Stock Purchase Warrants.***

 

Under the terms of the registration rights agreementwe entered into with the holders of our Series A Convertible PreferredStock, we are obligated to register the common stock underlying the Series AConvertible Preferred Stock and the Common Stock Purchase Warrants. Theregistration rights carry penalties in the event we do not meet theseregistration obligations. We agreed to use our commercially reasonable best effortsto cause the registration statement to be declared effective by the SEC by November 13,2008. If this deadline is not met, or if sales of all of the securities coveredby the registration statement cannot be made, whether because of our failure tokeep the registration statement effective, or for various other reasons, thenwe must pay liquidated damages in cash to the holders of our Series AConvertible Preferred Stock in the amount of 1.0% per month, on a daily prorata basis, up to a maximum of 8.0%, of the aggregate purchase 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 

 

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especiallyrelevant for us because Internet companies often experience significant stockprice volatility. If we faced such litigation, it could result in substantialcosts and diversion of management’s attention and resources, which couldadversely affect 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 andtrading price of our stock.***

 

Section 404 of the Sarbanes-Oxley Act of 2002and the related rules and regulations of the SEC require annual managementassessments of the effectiveness of our internal control over financialreporting and a report by our independent registered public accounting firmattesting to and reporting on these controls. We have dedicated significantamounts of time and resources to ensure compliance with this legislation forthe year ended December 31, 2007. Based on their evaluation, our principalexecutive and principal financial officers concluded that, as of December 31,2007, our disclosure controls and procedures were not effective due to thematerial weaknesses in our internal controls over (i) access to, andchanges in, our information technology financial applications and underlyingfinancial data; and (ii) the authority of our officers to obligate theCompany. Because of these material weaknesses, our management concluded that,as of December 31, 2007, we did not maintain effective internal controlover financial reporting based on the criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Additionally, Somekh Chaikin,a member of KPMG International, issued an adverse opinion with respect to theeffectiveness of our internal controls over financial reporting as of December 31,2007.  As a result, current and potentialstockholders could lose confidence in our financial reporting, which could harmour 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 Global Market listingrequirements, we are also required to provide our periodic reports, or makethem available, to our shareholders within prescribed time periods. If we arerequired to restate our financial statements in the future, any specificadjustment may be adverse and may cause our operating results and financialcondition, as restated, on an overall basis to be materially and adverselyimpacted. As a result, we or members of our management could be the subject ofadverse publicity, investigations and sanctions by such regulatory authoritiesas the Securities and Exchange Commission and subject to shareholder lawsuits.Any of the above consequences could cause our stock price to decline materiallyand could impose significant 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 NASDAQGlobal Market. If these events occur, our common stock listing on The NASDAQGlobal 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 and oneofficer reside in what 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 

 

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committedinside Israel and against Israeli targets in the West Bank and Gaza Strip. Inaddition, the recent armed conflict with Hezbollah on the northern border ofIsrael negatively affected business conditions in Israel. There is no indicationas to how long the current hostilities will last or whether there will be anyfurther escalation. Any further escalation in these hostilities or any futureconflict, political instability or violence in the region may have a negativeeffect on our business, harm our results of operations and adversely affect ourshare 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.***

 

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 just regardingthe professional development of the employee. If we are not able to enforcenon-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 includeinterest and penalties. This may harm our results of operations and adverselyaffect our financial condition. Our unrecognized tax benefits disclosed in thenotes to our financial statements for the period ending December 31, 2007,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 significant portion of the expenses associatedwith our Israeli operations, including personnel and facilities relatedexpenses, 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 sixmonths of 2008, the U.S. dollar depreciated against the NIS by 8.2%, 9.0%,and 12.8%, 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 of operationswill be adversely affected.

 
| **ITEM 2.** | **UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF  PROCEEDS** |
|-------------|------------------------------------------------------------------|
|        |                                                             |
| N/A         |                                                             |
|        |                                                             |
| **ITEM 3.** | **DEFAULTS UPON SENIOR SECURITIES**                              |
|        |                                                             |
| N/A         |                                                             |
|        |                                                             |
| **ITEM 4.** | **SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**          |
|        |                                                             |
| N/A         |                                                             |

 

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| **ITEM 5.** | **OTHER  INFORMATION** |
|-------------|------------------------|
|        |                   |
| N/A         |                   |
|        |                   |
| **ITEM 6.** | **EXHIBITS**           |

 
| 10.1       |   | Amendment to Amended and Restated Employment Agreement between GuruNet  Israel Ltd. and Robert S. Rosenschein dated July 30, 2008.                           |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                              |
|  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: August 4, 2008 | By:                      | /s/ Robert S. Rosenschein |
|                      |                     |   |
|                      |                     | Robert S. Rosenschein |
|                      |                     | Chief Executive Officer |
|                      |                     |   |
|                      |                     |   |
| Date: August 4, 2008 | By:                      | /s/ Steven Steinberg |
|                      |                     |   |
|                      |                     | Steven Steinberg |
|                      |                     | Chief Financial Officer |
|                      |                     | (Principal Financial  Officer) |

 

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